UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
  
  Form
10-Q
  
  x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
      ACT OF 1934
  For the
quarterly period ended September 30, 2010
  o
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
      ACT OF 1934
  For the
transition period from ________ to ________
  Commission
file number   000-51006
  HARBIN
ELECTRIC, INC.
 (Exact
name of registrant as specified in its charter)
  Nevada
              98-0403396(State
      or other jurisdiction of
                incorporation
      or organization)
              (I.R.S.
      Employer
                Identification
      Number)
  No. 9 Ha Ping Xi Lu, Ha Ping Lu Ji
Zhong Qu
 Harbin
Kai Fa Qu, Harbin, People’s Republic of China 150060
 (Address
of principal executive offices) (Zip Code)
  Telephone:
86-451-86116757
 (Registrant’s
telephone number, including area code)
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the past 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x Noo
  Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes oNoo
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
      accelerated filer o
              Accelerated
      filer xNon-accelerated
      filer (Do not check if a smaller reporting company) o
              Smaller
      reporting company o
  Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes o No x
 
 APPLICABLE
ONLY TO CORPORATE ISSUERS
  Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of November 5, 2010: 31,250,820 shares of common stock, par value
$0.00001 per share.
 
 
 
 TABLE
OF CONTENTS
 
  PagePart I.
      Financial Information
                
                2Item
      1. Financial Statements
                
                2Consolidated
      Balance Sheets
                  As
      of September 30, 2010 (Unaudited) and December 31, 2009
                
                2Consolidated
      Statements of Operations and Other Comprehensive Income
(Loss)
                  For
      the Three Months and Nine Months Ended September 30, 2010 and 2009
      (Unaudited)
                
                3Consolidated
      Statements of Changes in Equity (Unaudited)
                
                4Consolidated
      Statements of Cash Flows
                  For
      the Nine Months Ended September 30, 2010 and 2009
    (Unaudited)
                
                5Notes
      to the Consolidated Financial Statements (Unaudited)
                
                6Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                
                39Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                
                51Item
      4. Controls and Procedures
                
                51Part
      II. Other Information
                
                51Item
      1. Legal Proceedings
                
                51Item
      1A. Risk Factors
                
                52Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                
                57Item
      3. Defaults Upon Senior Securities
                
                57Item
      4. (Removed and Reserved)
                
                57Item
      5. Other Information
                
                57Item
      6. Exhibits
                
                57Signatures
                
                58Index
      to Exhibits
                
                59
  - 1
-
  PART
I. FINANCIAL INFORMATION
  Item
1. Financial Statements




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 AS OF
SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
  ASSETSSeptember
      30,
                                        
                                        
                                        December
      31,2010
                                        
                                        
                                        2009(Unaudited)CURRENT
      ASSETS:Cash
      and cash equivalents
                                        
                                        $
                                        55,531,683
                                        
                                        
                                        $
                                        92,902,400Restricted
      cash
                                        
                                        
                                        2,997,985
                                        
                                        
                                        
                                        3,522,009Notes
      receivable
                                        
                                        
                                        4,733,685
                                        
                                        
                                        
                                        1,086,929Accounts
      receivable, net
                                        
                                        
                                        89,489,395
                                        
                                        
                                        
                                        93,322,885Inventories,
      net
                                        
                                        
                                        73,898,882
                                        
                                        
                                        
                                        74,913,877Other
      receivables & prepaid expenses
                                        
                                        
                                        3,459,863
                                        
                                        
                                        
                                        5,828,453Advances
      on inventory purchases
                                        
                                        
                                        13,578,174
                                        
                                        
                                        
                                        11,718,544Total
      current assets
                                        
                                        
                                        243,689,667
                                        
                                        
                                        
                                        283,295,097PLANT
      AND EQUIPMENT, net
                                        
                                        
                                        200,725,156
                                        
                                        
                                        
                                        156,364,548OTHER
      ASSETS:Debt
      issuance costs, net
                                        
                                        
                                        -
                                        
                                        
                                        
                                        359,255Advance
      on non-current assets
                                        
                                        
                                        22,532,583
                                        
                                        
                                        
                                        13,666,414Goodwill
                                        
                                        
                                        53,109,595
                                        
                                        
                                        
                                        54,073,754Other
      intangible assets, net
                                        
                                        
                                        23,336,090
                                        
                                        
                                        
                                        21,472,471Other
      assets
                                        
                                        
                                        1,063,957
                                        
                                        
                                        
                                        1,722,693Total
      other assets
                                        
                                        
                                        100,042,225
                                        
                                        
                                        
                                        91,294,587Total
      assets
                                        
                                        $
                                        544,457,048
                                        
                                        
                                        $
                                        530,954,232LIABILITIES AND SHAREHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Notes
      payable - short term
                                        
                                        $
                                        4,029,924
                                        
                                        
                                        $
                                        4,533,268Accounts
      payable
                                        
                                        
                                        53,849,313
                                        
                                        
                                        
                                        47,099,135Short
      term loans
                                        
                                        
                                        52,876,907
                                        
                                        
                                        
                                        44,439,629Customer
      deposits
                                        
                                        
                                        14,613,173
                                        
                                        
                                        
                                        18,455,842Accrued
      liabilities and other payables
                                        
                                        
                                        9,780,569
                                        
                                        
                                        
                                        12,329,394Taxes
      payable
                                        
                                        
                                        6,578,910
                                        
                                        
                                        
                                        8,233,862Amounts
      due to original shareholders
                                        
                                        
                                        748,500
                                        
                                        
                                        
                                        28,681,976Current
      portion of notes payable, net
                                        
                                        
                                        -
                                        
                                        
                                        
                                        7,660,210Total
      current liabilities
                                        
                                        
                                        142,477,296
                                        
                                        
                                        
                                        171,433,316LONG
      TERM LIABILITIES:Long
      term bank loans
                                        
                                        
                                        -
                                        
                                        
                                        
                                        4,401,000Warrant
      liability
                                        
                                        
                                        3,502,097
                                        
                                        
                                        
                                        4,623,558Total
      liabilities
                                        
                                        
                                        145,979,393
                                        
                                        
                                        
                                        180,457,874COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY:Common
      Stock, $0.00001 par value, 100,000,000 shares authorized,31,067,471
      and 31,067,471 shares issued and outstandingas
      of September 30, 2010 and December 31, 2009, respectively
                                        
                                        
                                        310
                                        
                                        
                                        
                                        310Paid-in-capital
                                        
                                        
                                        213,471,172
                                        
                                        
                                        
                                        218,094,374Retained
      earnings
                                        
                                        
                                        128,432,489
                                        
                                        
                                        
                                        69,594,111Statutory
      reserves
                                        
                                        
                                        28,132,469
                                        
                                        
                                        
                                        22,869,423Accumulated
      other comprehensive income
                                        
                                        
                                        25,662,943
                                        
                                        
                                        
                                        18,638,299Total
      shareholders' equity
                                        
                                        
                                        395,699,383
                                        
                                        
                                        
                                        329,196,517NONCONTROLLING
      INTERESTS
                                        
                                        
                                        2,778,272
                                        
                                        
                                        
                                        21,299,841Total
      liabilities and shareholders' equity
                                        
                                        $
                                        544,457,048
                                        
                                        
                                        $
                                        530,954,232
    - 2
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
 FOR THE
THREE MONTHS AND NINE MONTHS ENDED  SEPTEMBER 30, 2010 AND
2009
 (Unaudited)
  Three
      Months Ended September 30
                                      
                                      
                                      Nine
      Months Ended September 302010
                                      
                                      
                                      2009
                                      
                                      
                                      2010
                                      
                                      
                                      2009REVENUES
                                      
                                      $
                                      109,354,544
                                      
                                      
                                      $
                                      46,932,031
                                      
                                      
                                      $
                                      320,275,671
                                      
                                      
                                      $
                                      116,020,408COST
      OF SALES
                                      
                                      
                                      75,779,744
                                      
                                      
                                      
                                      30,170,797
                                      
                                      
                                      
                                      215,626,614
                                      
                                      
                                      
                                      75,472,120GROSS
      PROFIT
                                      
                                      
                                      33,574,800
                                      
                                      
                                      
                                      16,761,234
                                      
                                      
                                      
                                      104,649,057
                                      
                                      
                                      
                                      40,548,288RESEARCH
      AND DEVELOPMENT EXPENSE
                                      
                                      
                                      1,663,465
                                      
                                      
                                      
                                      468,309
                                      
                                      
                                      
                                      2,620,443
                                      
                                      
                                      
                                      1,270,111SELLING,
      GENERAL AND  ADMINISTRATIVE EXPENSES
                                      
                                      
                                      10,058,730
                                      
                                      
                                      
                                      3,249,281
                                      
                                      
                                      
                                      24,361,542
                                      
                                      
                                      
                                      9,393,121INCOME
      FROM OPERATIONS
                                      
                                      
                                      21,852,605
                                      
                                      
                                      
                                      13,043,644
                                      
                                      
                                      
                                      77,667,072
                                      
                                      
                                      
                                      29,885,056OTHER
      EXPENSE (INCOME), NETOther
      income, net
                                      
                                      
                                      (739,840
                                      )
                                      
                                      
                                      (1,062,650
                                      )
                                      
                                      
                                      (3,185,801
                                      )
                                      
                                      
                                      (3,702,914
                                      )Interest
      expense, net
                                      
                                      
                                      1,132,671
                                      
                                      
                                      
                                      8,478,316
                                      
                                      
                                      
                                      3,757,452
                                      
                                      
                                      
                                      10,762,228Loss
      on currency hedge settlement
                                      
                                      
                                      -
                                      
                                      
                                      
                                      9,000,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      9,000,000Gain
      on debt repurchase
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (4,155,000
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (4,155,000
                                      )Loss
      from disposal of subdivision
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      623,158
                                      
                                      
                                      
                                      -Change
      in fair value of warrants
                                      
                                      
                                      301,918
                                      
                                      
                                      
                                      736,546
                                      
                                      
                                      
                                      (1,121,461
                                      )
                                      
                                      
                                      12,177,915Total
      other expense, net
                                      
                                      
                                      694,749
                                      
                                      
                                      
                                      12,997,212
                                      
                                      
                                      
                                      73,348
                                      
                                      
                                      
                                      24,082,229INCOME
      BEFORE PROVISION FOR INCOME TAXES
                                      
                                      
                                      21,157,856
                                      
                                      
                                      
                                      46,432
                                      
                                      
                                      
                                      77,593,724
                                      
                                      
                                      
                                      5,802,827PROVISION
      FOR INCOME TAXES
                                      
                                      
                                      3,296,165
                                      
                                      
                                      
                                      1,954,396
                                      
                                      
                                      
                                      11,150,418
                                      
                                      
                                      
                                      4,475,821NET
      INCOME (LOSS) BEFORE NONCONTROLLING INTEREST
                                      
                                      
                                      17,861,691
                                      
                                      
                                      
                                      (1,907,964
                                      )
                                      
                                      
                                      66,443,306
                                      
                                      
                                      
                                      1,327,006LESS:
      NET (LOSS) INCOME  ATTRIBUTABLE TO NONCONTROLLING
      INTEREST
                                      
                                      
                                      (11,241
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      2,341,882
                                      
                                      
                                      
                                      -NET
      INCOME (LOSS) ATTRIBUTABLE TO CONTROLLING INTEREST
                                      
                                      
                                      17,872,932
                                      
                                      
                                      
                                      (1,907,964
                                      )
                                      
                                      
                                      64,101,424
                                      
                                      
                                      
                                      1,327,006OTHER
      COMPREHENSIVE INCOME (LOSS)Foreign
      currency translation adjustment
                                      
                                      
                                      5,611,841
                                      
                                      
                                      
                                      292,230
                                      
                                      
                                      
                                      7,023,910
                                      
                                      
                                      
                                      (2,248
                                      )Foreign
      currency translation adjustment attributable to noncontrolling
      interest
                                      
                                      
                                      (6,577
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (6,768
                                      )
                                      
                                      
                                      -Change
      in fair value of derivative instrument
                                      
                                      
                                      -
                                      
                                      
                                      
                                      3,322
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (3,237,042
                                      )COMPREHENSIVE
      INCOME (LOSS)
                                      
                                      $
                                      23,478,196
                                      
                                      
                                      $
                                      (1,612,412
                                      )
                                      
                                      $
                                      71,118,566
                                      
                                      
                                      $
                                      (1,912,284
                                      )EARNINGS
      PER SHAREBasicWeighted
      average number of shares
                                      
                                      
                                      31,067,471
                                      
                                      
                                      
                                      27,076,669
                                      
                                      
                                      
                                      31,067,471
                                      
                                      
                                      
                                      23,861,950Earnings
      per share before noncontrolling interest
                                      
                                      $
                                      0.57
                                      
                                      
                                      $
                                      (0.07
                                      )
                                      
                                      $
                                      2.14
                                      
                                      
                                      $
                                      0.06Earnings
      per share attributable to controlling interest
                                      
                                      $
                                      0.58
                                      
                                      
                                      $
                                      (0.07
                                      )
                                      
                                      $
                                      2.06
                                      
                                      
                                      $
                                      0.06Earnings
      per share attributable to noncontrolling interest
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      0.08
                                      
                                      
                                      $
                                      -DilutedWeighted
      average number of shares
                                      
                                      
                                      31,281,802
                                      
                                      
                                      
                                      27,076,669
                                      
                                      
                                      
                                      31,327,763
                                      
                                      
                                      
                                      24,024,172Earnings
      per share before noncontrolling interest
                                      
                                      $
                                      0.57
                                      
                                      
                                      $
                                      (0.07
                                      )
                                      
                                      $
                                      2.12
                                      
                                      
                                      $
                                      0.06Earnings
      per share attributable to controlling interest
                                      
                                      $
                                      0.57
                                      
                                      
                                      $
                                      (0.07
                                      )
                                      
                                      $
                                      2.05
                                      
                                      
                                      $
                                      0.06Earnings
      per share attributable to noncontrolling interest
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      0.07
                                      
                                      
                                      $
                                      -
    - 3
-
 
 
 HARBIN ELECTRIC, INC. AND
SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
  Common
      stock
                            
                            
                            Additional
                            
                            
                            Retained
      earnings
                            
                            
                            Accumulated
      otherPar
                            
                            
                            paid-in
                            
                            
                            Unrestricted
                            
                            
                            Statutory
                            
                            
                            comprehensive
                            
                            
                            NoncontrollingShares
                            
                            
                            value
                            
                            
                            capital
                            
                            
                            earnings
                            
                            
                            reserves
                            
                            
                            income
      (loss)
                            
                            
                            interest
                            
                            
                            TotalBALANCE,
      January 1, 2009
                            
                            
                            22,102,078
                            
                            
                            $
                            220
                            
                            
                            $
                            95,029,290
                            
                            
                            $
                            52,100,479
                            
                            
                            $
                            14,573,994
                            
                            
                            $
                            12,945,352
                            
                            
                            $
                            -
                            
                            
                            $
                            174,649,335Reclassification
      of warrant liabilities to equity
                            
                            
                            
                            
                            
                            
                            (13,613,718
                            )
                            
                            
                            6,142,280
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (7,471,438
                            )Exercise
      of stock warrants at $7.80
                            
                            
                            1,428,846
                            
                            
                            
                            14
                            
                            
                            
                            26,122,124
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            26,122,138Amortization
      of stock compensation
                            
                            
                            
                            
                            
                            
                            
                            827,218
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            827,218Non
      cash exercise of warrant at $12.25
                            
                            
                            85,227
                            
                            
                            
                            1
                            
                            
                            
                            1,055,266
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,055,267Stock
      issuance for cash at $16
                            
                            
                            7,187,500
                            
                            
                            
                            72
                            
                            
                            
                            107,521,878
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            107,521,950Net
      income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,327,006
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,327,006Adjustment
      to statutory reserve
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (3,326,666
                            )
                            
                            
                            3,326,666
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Foreign
      currency translation gain
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (2,248
                            )
                            
                            
                            
                            
                            
                            
                            (2,248
                            )Net
      change related to cash flow hedge
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (3,237,042
                            )
                            
                            
                            
                            
                            
                            
                            (3,237,042
                            )Reclassification
      of change in cash flow hedge to earnings
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            9,000,000
                            
                            
                            
                            
                            
                            
                            
                            9,000,000BALANCE,
      September 30, 2009 (Unaudited)
                            
                            
                            30,803,651
                            
                            
                            
                            307
                            
                            
                            
                            216,942,058
                            
                            
                            
                            56,243,099
                            
                            
                            
                            17,900,660
                            
                            
                            
                            18,706,062
                            
                            
                            
                            -
                            
                            
                            
                            309,792,186Amortization
      of stock compensation
                            
                            
                            
                            
                            
                            
                            
                            383,819
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            383,819Noncontrolling
      interest in acquiree
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            17,957,815
                            
                            
                            
                            17,957,815Net
      income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            18,319,775
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3,491,414
                            
                            
                            
                            21,811,189Exercise
      of stock options at $3.10
                            
                            
                            65,000
                            
                            
                            
                            1
                            
                            
                            
                            201,499
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            201,500Exercise
      of stock options at $8.10
                            
                            
                            70,000
                            
                            
                            
                            1
                            
                            
                            
                            566,999
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            567,000Cashless
      exercise of options
                            
                            
                            128,820
                            
                            
                            
                            1
                            
                            
                            
                            (1
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Adjustment
      to statutory reserve
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (4,968,763
                            )
                            
                            
                            4,968,763
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Dividend
      distribution
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (150,071
                            )
                            
                            
                            (150,071
                            )Foreign
      currency translation gain
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (67,763
                            )
                            
                            
                            683
                            
                            
                            
                            (67,080
                            )BALANCE,
      December 31, 2009
                            
                            
                            31,067,471
                            
                            
                            
                            310
                            
                            
                            
                            218,094,374
                            
                            
                            
                            69,594,111
                            
                            
                            
                            22,869,423
                            
                            
                            
                            18,638,299
                            
                            
                            
                            21,299,841
                            
                            
                            
                            350,496,358Amortization
      of stock compensation
                            
                            
                            
                            
                            
                            
                            
                            764,006
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            764,006Net
      income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            64,101,424
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2,341,882
                            
                            
                            
                            66,443,306Adjustment
      to statutory reserve
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (5,263,046
                            )
                            
                            
                            5,263,046
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Deconsolidation
      of subsidiaries
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            23
                            
                            
                            
                            (1,604,613
                            )
                            
                            
                            (1,604,590
                            )Acquisition
      of noncontrolling interest
                            
                            
                            
                            
                            
                            
                            
                            (5,387,208
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            711
                            
                            
                            
                            (22,134,423
                            )
                            
                            
                            (27,520,920
                            )Increase
      in noncontrolling interest
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2,882,353
                            
                            
                            
                            2,882,353Foreign
      currency translation gain
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            7,023,910
                            
                            
                            
                            (6,768
                            )
                            
                            
                            7,017,142BALANCE,
      September 30, 2010 (Unaudited)
                            
                            
                            31,067,471
                            
                            
                            $
                            310
                            
                            
                            $
                            213,471,172
                            
                            
                            $
                            128,432,489
                            
                            
                            $
                            28,132,469
                            
                            
                            $
                            25,662,943
                            
                            
                            $
                            2,778,272
                            
                            
                            $
                            398,477,655
 
 - 4
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 
 Nine
      Months Ended September 30,2010
                            
                            
                            2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income attibutable to noncontrolling interest
                            
                            $
                            2,341,882
                            
                            
                            $
                            -Net
      income attibutable to controlling interest
                            
                            
                            64,101,424
                            
                            
                            
                            1,327,006Consolidated
      net income
                            
                            
                            66,443,306
                            
                            
                            
                            1,327,006Adjustments
      to reconcile net income to cashprovided
      by (used in) operating activities:Depreciation
                            
                            
                            6,201,903
                            
                            
                            
                            1,943,019Amortization
      of intangible assets
                            
                            
                            1,177,662
                            
                            
                            
                            818,118Amortization
      of debt issuance costs
                            
                            
                            359,255
                            
                            
                            
                            1,172,056Amortization
      of debt discount
                            
                            
                            1,439,790
                            
                            
                            
                            10,215,337Provision
      for accounts receivable
                            
                            
                            1,889,235
                            
                            
                            
                            544,040Increase
      in inventory reserve
                            
                            
                            607,352
                            
                            
                            
                            -Share-based
      compensation
                            
                            
                            764,006
                            
                            
                            
                            827,218Gain
      on debt extinguishment
                            
                            
                            -
                            
                            
                            
                            (4,155,000
                            )Realized
      loss on extinguishment of derivative liability
                            
                            
                            -
                            
                            
                            
                            9,000,000Loss
      on disposal of equipment
                            
                            
                            374,479
                            
                            
                            
                            -Change
      in fair value of warrants
                            
                            
                            (1,121,461
                            )
                            
                            
                            12,177,915Loss
      from disposal of subdivision
                            
                            
                            622,182
                            
                            
                            
                            -Change
      in operating assets and liabilitiesNotes
      receivable
                            
                            
                            (3,680,037
                            )
                            
                            
                            884,957Accounts
      receivable
                            
                            
                            2,736,287
                            
                            
                            
                            (6,702,093
                            )Inventories
                            
                            
                            768,351
                            
                            
                            
                            9,314,625Other
      receivables & prepaid expenses
                            
                            
                            2,360,353
                            
                            
                            
                            16,337Advances
      on inventory purchases
                            
                            
                            (1,607,290
                            )
                            
                            
                            670,580Other
      assets
                            
                            
                            (152,493
                            )
                            
                            
                            (277,487
                            )Accounts
      payable
                            
                            
                            6,685,572
                            
                            
                            
                            604,793Customer
      deposits
                            
                            
                            (3,567,416
                            )
                            
                            
                            336,826Accrued
      liabilities & other payables
                            
                            
                            (1,302,360
                            )
                            
                            
                            (2,014,389
                            )Taxes
      payable
                            
                            
                            (1,814,519
                            )
                            
                            
                            746,996Net
      cash  provided by operating activities
                            
                            
                            79,184,157
                            
                            
                            
                            37,450,854CASH
      FLOWS FROM INVESTING ACTIVITIES:Payment
      for advances on intangible assets
                            
                            
                            -
                            
                            
                            
                            (2,313,190
                            )Payment
      for advances on equipment purchases
                            
                            
                            (8,422,121
                            )
                            
                            
                            (401,077
                            )Purchase
      of intangible assets
                            
                            
                            (93,250
                            )
                            
                            
                            (30,571
                            )Purchase
      of plant and equipment
                            
                            
                            (40,638,679
                            )
                            
                            
                            (758,515
                            )Proceeds
      from disposal of equipments and vehicles
                            
                            
                            321,236
                            
                            
                            
                            -Additions
      to construction-in-progress
                            
                            
                            (8,507,849
                            )
                            
                            
                            (5,945,269
                            )Payment
      to original shareholders for acquisition
                            
                            
                            (27,946,571
                            )
                            
                            
                            -Payment
      to acquire noncontrolling interests
                            
                            
                            (27,684,220
                            )
                            
                            
                            -Deconsolidation
      of cash held in disposed subdivisions
                            
                            
                            (602,948
                            )
                            
                            
                            -Proceeds
      from sale of controlling interests in subsidiaries
                            
                            
                            1,846,105
                            
                            
                            
                            -Net
      cash used in investing activities
                            
                            
                            (111,728,297
                            )
                            
                            
                            (9,448,622
                            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Decrease
      in restricted cash
                            
                            
                            585,697
                            
                            
                            
                            (513,065
                            )Proceeds
      from stock issuance
                            
                            
                            -
                            
                            
                            
                            107,491,950Proceeds
      received from conversion of warrants and options
                            
                            
                            -
                            
                            
                            
                            11,144,999Decrease
      in deposit to secure investment in cross currency hedge
                            
                            
                            -
                            
                            
                            
                            1,000,000Payment
      on cross currency hedge
                            
                            
                            -
                            
                            
                            
                            (9,000,000
                            )Payment
      on notes payable
                            
                            
                            (9,100,000
                            )
                            
                            
                            (32,745,000
                            )Proceeds
      from notes payable-short term
                            
                            
                            1,902,677
                            
                            
                            
                            4,098,656Payment
      on notes payable-short term
                            
                            
                            (2,488,374
                            )
                            
                            
                            (3,072,526
                            )Proceeds
      from short term loans
                            
                            
                            30,311,658
                            
                            
                            
                            4,251,110Repayment
      of short term loans
                            
                            
                            (27,079,658
                            )
                            
                            
                            (4,177,815
                            )Net
      cash (used in) provided by financing activities
                            
                            
                            (5,868,000
                            )
                            
                            
                            78,478,309EFFECTS
      OF EXCHANGE RATE CHANGE ON CASH
                            
                            
                            1,041,423
                            
                            
                            
                            (2,704
                            )(DECREASE)
      INCREASE IN CASH
                            
                            
                            (37,370,717
                            )
                            
                            
                            106,477,837Cash
      and cash equivalents, beginning of period
                            
                            
                            92,902,400
                            
                            
                            
                            48,412,263Cash
      and cash equivalents, end of period
                            
                            $
                            55,531,683
                            
                            
                            $
                            154,890,100
 - 5
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 Note
1 - Nature of Business
 
 Harbin
Electric, Inc. (the “Company” or “Harbin Electric”) is a Nevada Corporation,
incorporated on July 9, 2003. Through its subsidiaries, the Company designs,
develops, engineers, manufactures, sells and services a wide array of electric
motors including linear motors, specialty micro-motors, and industrial rotary
motors, with a focus on innovation, creativity, and value-added
products.  Products are sold in China and to certain international
markets.
 
 Recent
development
 
 In
October 2009, Harbin Electric acquired Xi’an Tech Full Simo Motor Co., Ltd.
(“Simo Motor”). Simo Motor formerly known as Xi’an Simo Motor Incorporation
(Group), was initially established in 1955 as a State-Owned Enterprise and one
of the major backbone companies of China’s electric motor industry. In January
2004, Simo Motor was privatized as a shareholding company from the former Xi’an
Electric Motor Works under the corporate laws of the People’s Republic of China
(“PRC”). Simo Motor develops and manufactures various industrial motors. Simo
Motor sells its products primarily in China and also in certain international
markets. Simo Motor had developed to a large enterprise group which consisted of
15 wholly-owned and 8 majority owned subsidiaries mainly engaged in
manufacturing and selling of electric motors. As a result, the Company’s
ownership to Simo Motor and all subsidiaries averaged to 87.2% at the time of
the acquisition. The remaining 12.8% was owned by noncontrolling shareholders.
See Note 18 for further discussion.
 
 On June
3, 2010, Simo Motor entered into four Share Purchase Agreements, each dated as
of June 3, 2010 with certain shareholders of four subsidiaries of Simo Motor
pursuant to which Simo Motor agreed to acquire all of the equity interests of
these subsidiaries that were not currently held by Simo
Motor.  Following consummation of the transactions contemplated by
these Share Purchase Agreements, Simo Motor owns 100% of the outstanding equity
of Xi’an Tech Full Lamination Co., Ltd. (“Lamination”), Xi’an Simo A’Da Motor
Co., Ltd. (“A’Da Motor”), Xi’an Tech Full Simo Moulds Co., Ltd. (“Moulds”) and
Xi’an Tech Full Simo Transportation Co., Ltd. (“Transportation”).  The
aggregate purchase price paid by Simo Motor for these equity interests in
Lamination, A’Da Motor, Moulds and Transportation is RMB188.2 million (US$27.60
million).
 
 In
addition, on June 3, 2010, Simo Motor entered into three Share Purchase
Agreements, each dated as of June 3, 2010 with certain shareholders of three
subsidiaries of Simo Motors pursuant to which Simo Motor agreed to sell its
equity interests in such subsidiaries to these
shareholders.  Following consummation of the transactions contemplated
by these three Share Purchase Agreements, Simo Motor no longer owns any of the
outstanding equity of Tianjin Simo Electric Co., Ltd. (“Electric”), Xi’an Simo
Science and Technology Development Co., Ltd. (“Science and Technology”) and
Xi’an Simo Imports and Exports Co., Ltd. (“Imports and Exports”).  The
aggregate sales price received by Simo Motor for these equity interests in
Electric, Science and Technology and Imports and Exports is RMB12.55 million
(US$1.84 million).
 
 On August
25, 2010, Advanced Automation Group, LLC, a Delaware limited liability company
(“AAG”) and an indirect wholly owned subsidiary of Harbin Electric, Inc., the
Company, Shelton Technology, LLC, a Michigan limited liability company
(“Shelton”) and Ms. Julie Chen, entered into an Option Exercise Agreement
(“Option Agreement”) dated as of August 25, 2010 and effective as of July 1,
2010, pursuant to which the Company exercised the right, previously granted to
the Company under a letter agreement dated April 9, 2007 between the Company and
Shelton, as amended on December 11, 2008, April 21, 2009 and December 7, 2009,
to require Shelton to contribute all right, title and interest in and to its
proprietary technologies, product designs, electric assembly manufacturing
techniques and U.S. customer accounts (“Intellectual Properties”) to AAG in
consideration for a limited liability company interest in AAG entitling Shelton
to a 49% share of AAG’s profits, losses, and distributions of its assets, in
accordance with AAG’s limited liability company agreement.
  - 6
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 In
connection with the Option Agreement, on August 25, 2010, Advanced Electric
Motors, Inc., a Delaware corporation (“AEM”) and a wholly owned subsidiary of
the Company, entered into an Amended and Restated Limited Liability Company
Agreement (“LLC Agreement”) dated as of August 25, 2010 and effective as of July
1, 2010, with Shelton whereby (i) Shelton agreed to contribute all right,
title and interest in and to its Intellectual Properties to AAG in consideration
for a membership interest in AAG entitling Shelton to receive 49% of any profits
earned by AAG through the terms of the LLC Agreement; and (ii) AEM agreed to
contribute all of AAG’s assets (subject to all of the liabilities of AAG) with
fair market value of $3 million in consideration for a membership interest in
AAG entitling AEM to receive 51% of any profits earned by AAG through the terms
of the LLC Agreement. The Intellectual Properties have been valued at $2,882,353
and the Company, through AEM, has previously contributed a total of $2 million
to AAG with the remaining $1 million to be paid by AEM to AAG prior to December
31, 2011.
 
 Note
2 - Summary of Significant Accounting Policies
 
 Basis of
presentation
 
 The
consolidated financial statements of Harbin Electric Inc. reflect the activities
of the following subsidiaries.  All material intercompany transactions
have been eliminated.
  Place incorporated
                
                Ownership
                  percentageAdvanced
      Electric Motors, Inc. (“AEM”)
                
                Delaware,
      USA
                
                
                100
                %Harbin
      Tech Full Electric Co., Ltd. (“HTFE”)
                
                Harbin,
      China
                
                
                100
                %Advanced
      Automation Group, LLC (“AAG”)
                
                Delaware,
      USA
                
                
                51
                %Advanced
      Automation Group Shanghai Co., Ltd. (“SAAG”)
                
                Shanghai,
      China
                
                
                51
                %Shanghai
      Tech Full Electric Co., Ltd. (“STFE”)
                
                Shanghai,
      China
                
                
                100
                %Weihai
      Tech Full Simo Motor Co., Ltd. (“Weihai”)
                
                Weihai,
      China
                
                
                100
                %Xi’an
      Tech Full Simo Motor Co., Ltd. (“Simo Motor”)
                
                Xi’an,
      China
                
                
                100
                %
 
 The
accompanying consolidated financial statements include the accounts of all
directly and indirectly owned subsidiaries listed above.
 
 The
interim unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States,
or GAAP, for interim financial information and with the instructions to
Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC
Regulation S-X and consistent with the accounting policies stated in the
Company’s 2009 Annual Report on Form 10-K. Certain information and note
disclosures normally included in financial statements prepared in accordance
with GAAP have been condensed or omitted pursuant to such rules and regulations.
Therefore, these financial statements should be read in conjunction with our
audited consolidated financial statements and notes thereto for the year ended
December 31, 2009, included in our Annual Report on Form 10-K filed with the
SEC.
 
 The
interim consolidated financial statements included herein are unaudited;
however, they contain all normal recurring accruals and adjustments that, in the
opinion of management, are necessary to present fairly our consolidated
financial position for the three and nine months ended September 30, 2010
and 2009, and our consolidated cash flows for the nine months ended September
30, 2010 and 2009. The results of operations for the three months and nine
months ended September 30, 2010 are not necessarily indicative of the results to
be expected for future quarters or the full year.
 
 Use of
estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions about future events. These estimates and the
underlying assumptions affect the reported amounts of assets, liabilities,
revenue and expenses, and disclosures about contingent assets and liabilities.
Such estimates and assumptions by management affect accrued expenses, the
valuation of accounts receivable, inventories, and long-lived assets, legal
contingencies, lives of plant and equipment, lives of intangible assets,
business combinations, goodwill, calculation of warranty accruals, taxes,
share-based compensation and others.
  - 7
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 Foreign currency
transactions
 
 Our
reporting currency is the US dollar.  The functional currency of PRC
subsidiaries is the Chinese Renminbi (“RMB”). Our results of operations and
financial position of the PRC subsidiaries are translated to United States
dollars using the end of period exchange rates as to assets and liabilities and
weighted average exchange rates as to revenues, expenses and cash flows. Capital
accounts are translated at their historical exchange rates when the capital
transaction occurred. The resulting currency translation adjustments are
recorded as a component of accumulated other comprehensive income (loss) within
stockholders’ equity.  As a result, translation adjustments
amount related to assets and liabilities reported on the consolidated statement
of cash flows will not necessarily agree with changes in the corresponding
consolidated balances on the balance sheet. Transaction gains and losses that
arise from exchange rate fluctuations on transactions denominated in a
currency other than the functional currency are included in the results of
operations as incurred.
 
 Translation
adjustments resulting from this process amounted to a gain of $5,611,841, and
$292,230 for the three months ended September 30, 2010 and 2009, respectively.
Translation adjustments resulting from this process amounted to a gain of
$7,023,910, and a loss of $2,248 for the nine months ended September 30, 2010
and 2009, respectively. The balance sheet amounts with the exception of
equity at September 30, 2010 and December 31, 2009 were translated at 6.698 RMB
to $1.00 and 6.837 RMB to $1.00, respectively.  The equity accounts
were stated at their historical exchange rate.  The average
translation rates applied to the revenues, expenses and cash flows statement
amounts for the nine months ended September 30, 2010 and 2009 were 6.816 RMB and
6.843 RMB to $1.00, respectively.
  Transaction
loss of $81,182 and gain of $432,657 were recognized during the three months
ended September 30, 2010 and 2009, respectively. Transaction loss of
$119,660 and gain of $227,967 were recognized during the nine months ended
September 30, 2010 and 2009, respectively.
 
 Concentration of
risks
 
 The
Company considers all highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents, for cash
flow statement purposes.  Cash includes cash on hand and demand
deposits in accounts maintained with state owned banks within the PRC and
with banks in the United States. The Company maintains balances at financial
institutions which, from time to time, may exceed Federal Deposit Insurance
Corporation insured limits for the banks located in the Unites States. Balances
at financial institutions or state owned banks within the PRC are not insured.
As of September 30, 2010 and December 31, 2009, the Company had deposits in
excess of federally insured limits totaling $57,812,658 and $92,701,730,
respectively. The Company has not experienced any losses in such accounts and
believes it is not exposed to any significant risks on its cash in bank
accounts.
 
 One major
customer accounted for approximately 10% of the net revenue for the three months
ended September 30, 2010. Total receivable balance due from this customer
was $16.5 million, representing 17% of total accounts receivable as of September
30, 2010. Two major customers accounted for approximately 37% of the net revenue
for the three months ended September 30, 2009. At September 30, 2009, the total
receivable balance due from these two customers was $12.7 million and $9.2
million, respectively, representing 34% and 25% of total accounts
receivable.
  No
customer accounted for more than 10% of the net revenue for the nine months
ended September 30, 2010.  Two major customers accounted for
approximately 31% of the net revenue for the nine months ended September 30,
2009, with each customer individually accounting for 18% and 13%,
respectively.
  - 8
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 No
vendor accounted for more than 10% of the raw material purchases for the three
months ended September 30, 2010. Three major vendors provided 44% of the
Company’s purchase of raw materials for the three months ended September 30,
2009, respectively.
 
 No vendor
accounted for more than 10% of the raw material purchases for the nine months
ended September 30, 2010. Four major vendors provided 74% of the Company’s
purchase of raw materials for the nine months ended September 30, 2009, with
each vendor individually accounting for 40%, 13%, 11% and 10%,
respectively.
 
 The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environment in the PRC, and by the general state
of the PRC's economy. The Company's operations in the PRC are subject to
specific considerations and significant risks not typically associated with
companies in the North America and Western Europe. These include risks
associated with, among others, the political, economic and legal environments
and foreign currency exchange. The Company's results may be adversely affected
by changes in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.
 
 Restricted
cash
 
 Restricted
cash represent amounts set aside by the Company in accordance with the Company’s
debt agreements with certain financial institutions.  These cash
amounts are designated for the purpose of paying down the principal amounts owed
to the financial institutions, and these amounts are held at the same financial
institutions with which the Company has debt agreements in the
PRC.  Due to the short-term nature of the Company’s debt obligations
to these banks, the corresponding restricted cash balances have been classified
as current in the consolidated balance sheets.
 
 Notes
receivable
 
 Notes
receivable arose from sale of goods and represented commercial drafts issued by
customers to the Company that are guaranteed by banks of the
customers.  Notes receivables are interest-free with maturity dates of
three or six months from date of issuance.
 
 Accounts
receivable
 
 Accounts
receivable are presented net of an allowance for bad debts account. The Company
maintains reserves for potential credit losses on accounts receivable.
Management reviews the composition of accounts receivable and analyzes
historical bad debts, customer concentrations, customer credit worthiness,
current economic trends and changes in customer payment patterns to evaluate the
adequacy of these reserves. The estimated loss rate is based on our historical
loss experience and also contemplates current market conditions. Delinquent
account balances are written-off after management has determined that the
likelihood of collection is not probable, and known bad debts are written off
against allowance for doubtful accounts when identified.
 
 Inventories
 
 Inventories
are valued at the lower of cost or market value, as determined on a first-in,
first-out basis, using the weighted average method. Management compares the cost
of inventories with the market value and an allowance is made for writing down
the inventory to its market value, if lower than cost. On an ongoing basis,
inventories are reviewed for potential write-down for estimated obsolescence or
unmarketable inventories equal to the difference between the costs of
inventories and the estimated net realizable value based upon forecasts for
future demand and market conditions. When inventories are written-down
to the lower of cost or market, it is not marked up subsequently based on
changes in underlying facts and circumstances.  Inventories are
composed of raw material for manufacturing electrical motors, work in process
and finished goods within the Company’s warehouse premise or consigned at a
customer site.  - 9
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Plant and equipment,
net
 
 Plant and
equipment are stated at cost, net of depreciation. Expenditures for maintenance
and repairs are charged to earnings as incurred; additions, renewals and
betterments are capitalized. When assets are retired or otherwise disposed of,
the related cost and accumulated depreciation are removed from the respective
accounts, and any gain or loss is included in operations. Depreciation of plant
and equipment is provided using the straight-line method for substantially all
assets with estimated lives as follows:
 
 Estimated Useful LifeBuildings
                20
      -40  yearsVehicle
                5-10  yearsOffice
      equipment
                5-6  yearsProduction
      equipment
                10-12  years
 
 Construction
in progress represents the costs incurred in connection with the construction of
buildings or new additions to the Company’s plant facilities.  No
depreciation is provided for construction in progress until such time as the
assets are completed and placed into service. Maintenance, repairs and minor
renewals are charged directly to expense as incurred. Major additions and
betterment to buildings and equipment are capitalized. Interest incurred during
construction is capitalized into construction in progress. All other interest is
expensed as incurred.
 
 The
Company recognizes an impairment loss when estimated cash flows generated by
those assets are less than the carrying amounts of the asset. Based on
management review, the Company believes that there were no impairments as of
September 30, 2010.
 
 Goodwill and other
intangible assets
 
 Goodwill
– the excess of the cost of an acquired entity over the net of the amounts
assigned to assets acquired and liabilities assumed shall be recognized as
goodwill.  Goodwill is tested for impairment at the reporting unit
level (operating segment or one level below an operating segment) on an annual
basis in the fourth quarter or more frequently if there are indicators of
impairment exist. For purposes of our goodwill impairment test, a two-step
test is used to identify the potential impairment and to measure the amount of
goodwill impairment, if any. The first step is to compare the fair value of the
reporting unit with its carrying amount, including goodwill. If the fair value
of the reporting unit exceeds its carrying amount, goodwill is considered not
impaired. If the carrying amount of a reporting unit exceeds its fair value, the
second step of the goodwill impairment test is performed to measure the amount
of impairment loss, if any. Under step two, the impairment loss is measured by
comparing the implied fair value of the reporting unit goodwill with the
carrying amount of that goodwill. If the carrying amount of the reporting unit
goodwill exceeds the implied fair value of that goodwill, an impairment loss is
recognized in an amount equal to that excess.
 
 General intangibles other
than goodwill
 
 Intangible
assets that are acquired individually or as part of a group of assets, other
than those acquired in a business combination, are initially recorded at their
fair value. The cost of a group of assets acquired in a transaction is allocated
to the individual assets based on their relative fair values. Goodwill does not
arise in such a transaction. Intangible assets that are acquired in a business
combination are accounted for in accordance with ASC Topic 805, Business Combinations. The
costs of intangible assets that are developed internally, as well as the costs
of maintaining or restoring intangible assets that have indeterminate lives or
that are inherent in a continuing business and related to the entity as a whole,
are expensed as incurred.
  - 10
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 The
accounting for intangible assets, other than goodwill, subsequent to acquisition
is based on the asset’s useful life. The useful life of the intangible asset is
the period over which the asset is expected to contribute directly or indirectly
to the entity’s future cash flows. An asset for which no legal, regulatory,
contractual, competitive, economic, or other factors limit its useful life is
considered to have an indefinite useful life.
 
 The
Company evaluates intangible assets for impairment, at least annually and
whenever events or changes in circumstances indicate that the assets might be
impaired.  We perform our annual impairment test in the fourth
quarter.
 
 Our
impairment test consists of a comparison of the fair value of the intangible
asset with its carrying amount. If the carrying amount of an intangible asset
exceeds its fair value, an impairment loss is recognized in an amount equal to
the excess.  As of September 30, 2010, management believes there was
no impairment.
 
 Accounting for long-lived
assets
 
 Long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. We assess
the recoverability of the assets based on the undiscounted future cash flow the
assets are expected to generate and recognize an impairment loss when estimated
undiscounted future cash flow expected to result from the use of the asset plus
net proceeds expected from disposition of the asset, if any, are less than the
carrying value of the asset. When we identify an impairment, we reduce the
carrying amount of the asset to its estimated fair value based on a discounted
cash flow approach or, when available and appropriate, to comparable market
values.  As of September 30, 2010, management believes there was no
impairment.
 
 Stock-based
compensation
 
 We record
share-based compensation expense based upon the grant date fair value of
share-based awards. The value of the award is principally recognized as expense
ratably over the requisite service periods. We use the Black-Scholes Merton
(“BSM”) option-pricing model, which incorporates various assumptions
including volatility, expected life and interest rates to determine fair value.
The Company’s expected volatility assumption is based on the historical
volatility of Company’s stock. The expected life assumption is primarily based
on the simplified method of the terms of the options. The risk-free interest
rate for the expected term of the option is based on the U.S. Treasury
yield curve in effect at the time of grant.
 
 The
Company is required to measure the cost of the equity instruments issued in
exchange for the receipt of goods or services from other than employees at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably determinable.
The value of equity instruments issued for consideration other than
employee services is determined on the earlier of a performance commitment or
completion of performance by the provider of goods or services.
 
 Stock
compensation expense is recognized based on awards expected to
vest.  GAAP requires forfeitures to be estimated at the time of grant
and revised in subsequent periods, if necessary, when actual forfeitures differ
from those estimates.  There were no estimated forfeitures as the
Company has a short history of issuing options.
 
 Revenue
recognition
 
 The
Company recognizes sales at the date of shipment to customers when a formal
arrangement exists, the price is fixed or determinable, the delivery is
completed, no other significant obligations of the Company exist and
collectability is reasonably assured. For products that are required to be
examined by customers, sales revenue is recognized after the customer
examination is passed. Payments received before all of the relevant
criteria for revenue recognition are recorded as customer deposits.
  - 11
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  In addition, revenue recognition
could be negatively impacted by returns. For our linear motor and specialty
micro-motor businesses, our products are custom products which are customer
specific, and no returns are allowed. We warrant our product for repair, only in
the event of defects for two years from the date of shipment.  We
charge such costs to cost of goods sold. For our industrial rotary motor
business, our products are standardized products and returns are allowed within
three days upon receipt of products by customers. We provide product warranty
for repair one year from the date of shipment. Historically, the returns and
defects have not been material. Should returns increase in the future it would
be necessary to adjust the estimates, in which case recognition of revenues
could be delayed.
 
 The
Company also provides after-sale services to our customers. Service revenue is
recognized as services are rendered, the customers have approved the completion
of the services and invoices have been issued and collectability is reasonably
assured. Customer billings for services not yet rendered are deferred and
recognized as revenue as the services are rendered and the associated deferred
revenue is included in current liabilities or long-term liabilities, as
appropriate.
 
 The
Company recognizes revenues with regards to the sales of consigned inventories
when the title and risks of ownership have been transferred to customers;
customers provide a persuasive evidence to notify the Company, and upon receipt
of the notification form from customers. The Company also performs periodic
inventory counts to confirm the inventory quantities held on
consignment.
 
 Shipping
and handling costs are included in selling, general and administrative costs and
totaled $1,613,132 and $618,070 for the three months ended September 30, 2010
and 2009, respectively. Shipping and handling costs are included in
selling, general and administrative costs and totaled $3,652,125 and $1,567,634
for the nine months ended September 30, 2010 and 2009,
respectively.
 
 Income
taxes
 
 The
Company utilizes the asset and liability method of accounting for income taxes,
under which deferred taxes are determined based on the temporary differences
between the financial statement and tax basis of assets and liabilities using
tax rates expected to be in effect during the years in which the basis
differences reverse. A valuation allowance is recorded when it is more likely
than not that some of the deferred tax assets will not be
realized.  GAAP also requires the recognition of deferred tax assets
and liabilities for the expected future tax consequences of events that have
been included in the financial statements or tax returns. As of January 1, 2007,
income tax positions must meet a more-likely-than-not recognition threshold to
be recognized.  A tax position is recognized as a benefit only if it
is “more likely than not” that the tax position would be sustained in a tax
examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50% likely
of being realized on examination. For tax positions not meeting the “more likely
than not” test, no tax benefit is recorded.
 
 Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each period end based on enacted tax laws
and statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.  No material deferred tax amounts were recorded at September
30, 2010 and December 31, 2009, respectively. Penalties and interest
incurred related to underpayment of income tax are classified as income tax
expense in the year incurred.  No significant penalties or interest
relating to income taxes have been incurred during the three and nine months
ended September 30, 2010 and 2009.  GAAP also provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosures and transition.
  - 12
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  The charge for taxation is based
on the results for the reporting period as adjusted for items, which are
non-assessable or disallowed.  It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet date.
 
 The
Company’s operating subsidiaries located in PRC are subject to PRC income tax.
The new Chinese Enterprise Income Tax (“EIT”) law was effective on January 1,
2008. Under the new Income Tax Laws of PRC, a company is generally subject to
income tax at an effective rate of 25% on income reported in the statutory
financial statements after appropriated tax adjustments. HTFE is located in a
specially designated region where HTFE is subject to a 10% EIT rate from January
1, 2008 to December 31, 2010. Weihai is currently at the standard 25%
income tax rate.  Our operations under STFE was  income tax
exempt in 2009 and is subject to preferential income tax rate of 11% in
2010 since its located in an economic development zone.  Simo Motor is
located in the Province of Shaanxi which is in the mid-west region of China, a
specially designated region where the government grants special income tax rates
to qualified entities.  Simo Motor qualifies for the “Go-west” special
income tax rate of 15% promulgated by the government and therefore is subject to
a 15% EIT rate from year 2007 to 2010.
 
 The
Company’s subsidiaries were paying the following tax rate for the three and nine
months ended September 30:
 
 2010
              
              
              2009Subsidiaries
              
              Income
                Tax
                Exemption
              
              
              Effective
                Income
                Tax Rate
              
              
              Income
                Tax
                Exemption
              
              
              Effective
                Income
                Tax RateHTFE
              
              
              15
              %
              
              
              10
              %
              
              
              15
              %
              
              
              10
              %Weihai
              
              
              0
              %
              
              
              25
              %
              
              
              0
              %
              
              
              25
              %STFE
              
              
              14
              %
              
              
              11
              %
              
              
              25
              %
              
              
              0
              %Simo
      Motor (a)
              
              
              10
              %
              
              
              15
              %
              
              
              n/a
              
              
              
              n/a
  
 (a)
              Simo
      Motor was acquired in October 2009 and the tax rate only applied to its
      results of operations included in the consolidated financial statements,
      which is the three months and nine months ended September 30,
      2010.
 
 The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three months ended September 30:
  2010
              
              
              2009U.S.
      statutory reserve rates
              
              
              34.0
              %
              
              
              34.0
              %Foreign
      income not recognized in U.S.
              
              
              -34.0
              %
              
              
              -34.0
              %China
      income taxes
              
              
              25.0
              %
              
              
              25.0
              %Tax
      exemption
              
              
              -16.8
              %
              
              
              -14.0
              %Other
      items (b)
              
              
              7.4
              %
              
              
              4,198.0
              %Effective
      income taxes
              
              
              15.6
              %
              
              
              4,209.0
              %
  
 (b)
              The
      7.4% represents the $2,519,765 of expenses incurred by the Company and its
      US subsidiaries AEM and AAG that are not subject to PRC income tax for the
      three months ended September 30, 2010. The 4,198.0% represents the
      $15,803,904 of expenses incurred by the Company and its US
      subsidiaries AEM and AAG that are not subject to PRC income tax for the
      three months ended September 30,
2009.
  - 13
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 The following table reconciles the U.S. statutory rates to the
Company’s effective tax rate for the nine months ended September 30:
  2010
              
              
              2009U.S.
      statutory reserve rates
              
              
              34.0
              %
              
              
              34.0
              %Foreign
      income not recognized in U.S.
              
              
              -34.0
              %
              
              
              -34.0
              %China
      income taxes
              
              
              25.0
              %
              
              
              25.0
              %Tax
      exemption
              
              
              -14.2
              %
              
              
              -14.0
              %Other
      items (c)
              
              
              3.6
              %
              
              
              66.0
              %Effective
      income taxes
              
              
              14.4
              %
              
              
              77.0
              %
  
 (c)
              The
      3.6% represents the $2,799,175 of expenses incurred by the Company and its
      US subsidiaries AEM and AAG that are not subject to PRC income tax for the
      nine months ended September 30, 2010. The 66% represents the $30,941,952
      of expenses incurred by the Company and its US subsidiaries AEM and AAG
      that are not subject to PRC income tax for the nine months ended September
      30, 2009.
 
 The
estimated tax savings for the three months ended September 30, 2010 and 2009
amounted to $2,385,355 and $2,111,267, respectively. The net effect on earnings
per share attributable to controlling interest had the income tax been applied
would decrease earnings per share from $0.58 to $0.50 for the three months ended
September 30, 2010, and $(0.07) to $(0.14) for the three months ended September
30, 2009.
 
 The
estimated tax savings for the nine months ended September 30, 2010 and 2009
amounted to $9,198,726 and $4,973,700, respectively. The net effect on earnings
per share attributable to controlling interest had the income tax been applied
would decrease earnings per share from $2.06 to $1.78 for the nine months ended
September 30, 2010, and $0.06 to $(0.15) for the nine months ended September 30,
2009.
 
 Harbin
Electric, AEM and AAG were organized in the United States and have incurred net
operating losses for income tax purposes for the nine months ended September 30,
2010.  The net operating loss carry forwards for United States income
taxes amounted to $31,410,254 which may be available to reduce future years’
taxable income.  These carry forwards will expire, if not utilized,
starting from 2027 through 2030.  Management believes that the
realization of the benefits from these losses appears uncertain due to the
Company’s limited operating history and continuing losses for United States
income tax purposes.  Accordingly, the Company has provided a 100%
valuation allowance on the deferred tax asset benefit to reduce the asset to
zero.  The net change in the valuation allowance for the nine months
ended September 30, 2010 was an increase of approximately $725,599. Management
will review this valuation allowance periodically and make adjustments
accordingly.
 
 The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $191,486,330 as of September 30, 2010, which is included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the future.
  - 14
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Value
added tax
 
 Sales
revenue represents the invoiced value of goods, net of a value-added tax
(“VAT”). All of the Company’s products that are sold in the PRC are subject to a
Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may
be offset by VAT paid by the Company on raw materials and other materials
included in the cost of producing their finished product. The Company recorded
VAT payable and VAT receivable net of payments in the financial statements. The
VAT tax return is filed offsetting the payables against the
receivables.
 
 VAT on
sales and VAT on purchases amounted to $19,997,361 and $15,283,482 for the three
months ended September 30, 2010, respectively.  VAT on sales and VAT
on purchases amounted to $5,542,376 and $3,154,460 for the three months
ended September 30, 2009, respectively. VAT on sales and VAT on purchases
amounted to $58,056,448 and $40,251,113 for the nine months ended September 30,
2010, respectively.  VAT on sales and VAT on purchases amounted
to $18,237,779 and $10,740,918 for the nine months ended September 30,
2009, respectively.  Sales and purchases are recorded net of VAT
collected and paid as the Company acts as an agent for the
government.
 
 Advertising
costs
 
 The
Company expenses the cost of advertising as incurred in selling, general and
administrative costs. The Company incurred $9,120 and $10,983 for the three
months ended September 30, 2010 and 2009, respectively. The Company
incurred $66,525 and $68,088 for the nine months ended September 30, 2010 and
2009, respectively. The Company expenses the cost of advertising as
incurred in selling, general and administrative costs.
 
 Research and development
costs
 
 Research
and development costs are expensed as incurred.  The costs of material
and equipment that are acquired or constructed for research and development
activities and have alternative future uses are classified as plant and
equipment and depreciated over their estimated useful lives.
 
 Noncontrolling
interest
 
 The
Company owns 100% of Simo Motor. The 0.05% of noncontrolling interest was
indirectly from Simo Motor’s subsidiary Qishan Simo Moulding Co,
Ltd.  Effective July 1, 2010, 49% of AAG and SAAG was owned by
noncontrolling interests, Shelton Technology, LLC, a Michigan limited
liability company.
 
 Fairvalue of financial
instruments
 
 On
January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009, the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:
 
 -
              Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.
 
 -
              Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.
 
 -
              Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.
  - 15
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 Effective January 1, 2009, a total of 2,030,158 warrants
previously treated as equity pursuant to the derivative treatment exemption is
no longer afforded equity treatment because the strike price of the warrants is
denominated in US dollar, a currency other than the Company’s functional
currency, the Chinese RMB.  As a result, the warrants are not
considered indexed to the Company’s own stock, and as such, all future changes
in the fair value of these warrants will be recognized currently in earnings
until such time as the warrants are exercised or expired. The Company
reclassified the fair value of these warrants from equity to liability, as if
these warrants were treated as a derivative liability since their issuance
in August 2006. On January 1, 2009, the Company reclassified from
additional paid-in capital, as a cumulative effect adjustment, $6.1 million
to beginning retained earnings and $7.4 million to warrant liabilities to
recognize the fair value of such warrants. As of September 30, 2010, the Company
has 366,697 warrants outstanding. The fair value of the outstanding warrants was
$3.5 million.  The Company recognized a total of $0.3 million loss for
the three months ended September 30, 2010 from the change in fair value of the
warrants and $1.1 million gain and for the nine months ended September
30, 2010.
 
 These
common stock purchase warrants do not trade in an active securities market, and
as such, we estimate the fair value of these warrants using the Black-Scholes
Option Pricing Model using the following assumptions:
 
 September
      30,
                2010
              
              
              January
      1,
                2009(Unaudited)
              
              
              (Unaudited)Annual
      dividend yield
              
              
              -
              
              
              
              -Expected
      life (years)
              
              
              1.92
              
              
              
              3.67Risk-free
      interest rate
              
              
              0.62
              %
              
              
              1.20
              %Expected
      volatility
              
              
              70
              %
              
              
              66
              %
 
 Expected
volatility is based primarily on historical volatility. Historical volatility
was computed using daily pricing observations for recent periods that correspond
to the term of the warrants. We believe this method produces an estimate that is
representative of our expectations of future volatility over the expected term
of these warrants. We have no reason to believe future volatility over the
expected remaining life of these warrants likely to differ materially from
historical volatility. The expected life is based on the remaining term of the
warrants. The risk-free interest rate is based on U.S. Treasury securities
according to the remaining term of the warrants.
 
 Carrying Value
                as of
                September
      30,
                2010
              
              Fair Value Measurements at September
      30, 2010 Using
                Fair Value Hierarchy(Unaudited)
              
              Level
      1
              
              Level
      2
              
              Level
      3Fair
      value of warrant liabilities
              
              $
              3,502,097
              
              
              
              $
              3,502,097
 
 Other
than the warranty liabilities, the Company did not identify any assets and
liabilities that are required to be presented on the balance sheet at fair
value.
 
 Recent Accounting
Pronouncements
  In June
2009, the FASB issued authoritative guidance to eliminate the exception to
consolidate a qualifying special-purpose entity, change the approach to
determining the primary beneficiary of a variable interest entity and require
companies to more frequently re-assess whether they must consolidate variable
interest entities. Under the new guidance, the primary beneficiary of a variable
interest entity is identified qualitatively as the enterprise that has both (a)
the power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance, and (b) the obligation
to absorb losses of the entity that could potentially be significant to the
variable interest entity or the right to receive benefits from the entity that
could potentially be significant to the variable interest entity. This guidance
becomes effective for the Company at its fiscal 2011 year-end and interim
reporting periods thereafter. The Company does not expect this guidance to have
a material impact on its consolidated financial statements.
  - 16
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 In
January 2010, FASB issued ASU No. 2010-01– Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and
Earnings Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The adoption of this ASU did not have impact on the
Company’s consolidated financial statements.
 
 In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity. The amendments in this update are effective
beginning in the period that an entity adopts SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements – An Amendment of ARB No.
51.” If an entity has previously adopted SFAS No. 160 as of the date the
amendments in this update are included in the Accounting Standards Codification,
the amendments in this update are effective beginning in the first interim or
annual reporting period ending on or after December 15, 2009. The amendments in
this update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160. The adoption of this ASU did not have a material impact on
the Company’s consolidated financial statements.
 
 In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers. 2) Activity in Level 3 fair value measurements. In
the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. These disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU, however, the
Company does not expect the adoption of this ASU to have a material impact
on its consolidated financial statements.
 
 In
February 2010, FASB issued ASU No. 2010-9 – Amendments to Certain Recognition
and Disclosure Requirements. This update addresses certain implementation issues
related to an entity’s requirement to perform and disclose subsequent-events
procedures, removes the requirement that public companies disclose the date of
their financial statements in both issued and revised financial statements.
According to the FASB, the revised statements include those that have been
changed to correct an error or conform to a retrospective application of U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.
  - 17
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  In March 2010, FASB issued ASU No.
2010-10 –Amendments for Certain Investment Funds. This update defers the
effective date of the amendments to the consolidation requirements made by FASB
Statement 167 to a reporting entity’s interest in certain types of entities. The
deferral will mainly impact the evaluation of reporting enterprises’ interests
in mutual funds, private equity funds, hedge funds, real estate investment
entities that measure their investment at fair value, real estate investment
trusts, and venture capital funds. The ASU also clarifies guidance in Statement
167 that addresses whether fee arrangements represent a variable interest for
all service providers and decision makers. The ASU is effective for interim and
annual reporting periods in fiscal year beginning after November 15, 2009. The
adoption of this ASU did not have a material impact on the Company’s
consolidated financial statements.
 
 In March
2010, FASB issued ASU No. 2010-11 –Scope Exception Related to Embedded Credit
Derivatives. Embedded credit-derivative features related only to the transfer of
credit risk in the form of subordination of one financial instrument to another
are not subject to potential bifurcation and separate accounting as clarified by
recently issued FASB guidance. Other embedded credit-derivative features are
required to be analyzed to determine whether they must be accounted for
separately. This update provides guidance on whether embedded credit-derivative
features in financial instruments issued by structures such as collateralized
debt obligations (CDOs) and synthetic CDOs are subject to bifurcation and
separate accounting. The guidance is effective at the beginning of a company’s
first fiscal quarter beginning after June 15, 2010. The adoption of this ASU did
not have a material impact on the Company’s consolidated financial
statements.
 
 In July
2010, the FASB issued Accounting Standards Update 2010-20 which amends
“Receivables” (Topic 310). ASU 2010-20 is intended to provide additional
information to assist financial statement users in assessing an entity’s risk
exposures and evaluating the adequacy of its allowance for credit losses. The
disclosures as of the end of a reporting period are effective for interim and
annual reporting periods ending on or after December 15, 2010. The disclosures
about activity that occurs during a reporting period are effective for interim
and annual reporting periods beginning on or after December 15, 2010. The
amendments in ASU 2010-20 encourage, but do not require, comparative disclosures
for earlier reporting periods that ended before initial adoption. However, an
entity should provide comparative disclosures for those reporting periods ending
after initial adoption. While ASU 2010-20 will not have a material impact on our
consolidated financial statements, we expect that it will expand our disclosures
related to notes receivables.
 
 Reclassifications
 
 Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.
 
 Note
3 – Disposal of subdivisions
 
 Effective
April 1, 2010, Simo Motor, a PRC subsidiary of the Company, sold its equity
interests in its three subsidiaries, Tianjin Simo, Science and Technology and
Imports and Exports, to certain shareholders of these three
subsidiaries.  As a result of the above dispositions, Simo Motor no
longer owns any of the outstanding equity of these three
subsidiaries.  The Company evaluates the impact of the disposal of the
above entities, which results in the Company failing the test in ASC
205-20-45.  The failure of this test therefore does not require the
classification of the disposal of the above entities as a discontinued
operation.  The aggregate sales price for the equity interests in
Tianjin Simo, Science and Technology and Imports and Exports is RMB12.55 million
(US$1.84 million).  A net loss of $623,158 was recorded in loss from
disposal of subdivisions, net of income taxes in the Company’s Consolidated
Statement of Operations.
  - 18
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Note
4 – Acquisition of the noncontrolling interests
 
 Effective
April 1, 2010, Simo Motor, a PRC subsidiary of the Company, acquired all of the
equity interests in its four subsidiaries, Lamination, A’Da Motor, Moulds, and
Transportation. As a result of the above acquisitions, Simo Motor now owns 100%
of the outstanding equity of these four subsidiaries. The aggregate purchase
price for the equity interests in these four subsidiaries is $27.60 million and
it was fully paid during the nine months ended September 30, 2010.
 
 The
effects of changes in the Company’s ownership interest in its subsidiaries are
below:
 
 For
      the nine months ended
                      September
      30,2010
                    
                    2009(Unaudited)Net
      income attributable to controlling interest
                    
                    $
                    64,101,424
                    
                    
                    $
                    1,327,006Transfer
      (to) from the noncontrolling interestDecrease
      in Paid-in Capital for purchase of noncontrollinginterests
                    
                    
                    (5,387,208
                    )
                    
                    
                    -Change
      from net income attributable to controlling interest and transfers from
      noncontrolling interest
                    
                    
                    58,714,216
                    
                    
                    
                    1,327,006
                    )
 
 Note
5 – Supplemental disclosure of cash flows
 
 The
Company prepares its statements of cash flows using the indirect method as
defined under the ASC Topic 230. The following information relates to non-cash
investing and financing activities for the nine months ended September 30, 2010
and 2009.
 
 Total
interest paid amounted to $2,464,778 and $11,050,500 for the nine months ended
September 30, 2010 and 2009, respectively.
 
 Total
income tax paid amounted to $10,916,173 and $3,503,929 for the nine months ended
September 30, 2010 and 2009, respectively.
 
 For the
nine months ended September 30, 2010, equipment in the amount of $346.679 was
transferred as payment to accounts payable for $173,965 and as payment to other
payables for the amount of $172,714.  The Notes receivable in the
amount of 118,460 and other receivable at $618,443 were used for equipment
purchases for the nine months ended September 30, 2010.
 
 For the
nine months ended September 30, 2010, intangible assets in the amount of
$2,882,353 was contributed to AAG in exchange for 49% of ownership
interest.
 
 Note
6 – Accounts receivable, net
 
 Accounts
receivable consisted of the following:
 
 September
      30,
              
              
              December 31,2010
              
              
              2009(Unaudited)Accounts
      receivable
              
              $
              95,459,752
              
              
              $
              97,302,153Less:
      allowance for bad debts
              
              
              (5,970,357)
              
              
              
              (3,979,268)Accounts
      receivable, net
              
              $
              89,489,395
              
              
              $
              93,322,885
  - 19
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 The
following table consists of allowance for bad debts:
 
 Allowance
      for bad debts at January 1, 2009
                      
                      $
                      153,155Provision
      for bad debts
                      
                      
                      548,077Accounts
      receivable write off
                      
                      
                      -Effect
      of foreign currency translation
                      
                      
                      (3,630
                      )Allowance
      for bad debts at September 30, 2009 (Unaudited)
                      
                      
                      697,602Recovery
      of bad debts
                      
                      
                      (542,975
                      )Accounts
      receivable write off
                      
                      
                      (437,191
                      )Increase
      in allowance from acquisition of Simo Motor
                      
                      
                      4,263,411Effect
      of foreign currency translation
                      
                      
                      (1,579
                      )Allowance
      for bad debts at December 31, 2009
                      
                      
                      3,979,268Provision
      for bad debts
                      
                      
                      1,889,235Accounts
      receivable write off
                      
                      
                      -Decrease
      in allowance due to disposal of subdivisions
                      
                      
                      (12,533
                      )Effect
      of foreign currency translation
                      
                      
                      114,387Allowance
      for bad debts at September 30, 2010 (Unaudited)
                      
                      $
                      5,970,357
 
 Note
7 – Inventories, net
 
 The
following is a summary of inventories by major category:
 
 September
      30,
              
              
              December 31,2010
              
              
              2009(Unaudited)Raw
      and packing materials
              
              $
              10,984,222
              
              
              $
              11,826,804Work
      in process
              
              
              25,760,631
              
              
              
              28,434,522Finished
      goods
              
              
              33,684,301
              
              
              
              25,471,544Finished
      goods - consignment
              
              
              13,166,618
              
              
              
              18,077,870Inventory
      valuation allowance
              
              
              (9,696,890)
              
              
              
              (8,896,863)Total
      inventories, net
              
              $
              73,898,882
              
              
              $
              74,913,877
 
 As of
September 30, 2010 and December 31, 2009, total inventory valuation allowance
amounted to $9,696,890 and $8,896,863, respectively.  All inventory
valuation allowance is from the subsidiary Simo Motor acquired on October 2,
2009.
 
 Allowance
      for inventory valuation at January 1, 2009
              
              $
              -Additional
      reserves
              
              
              -Recovery
      of reserves
              
              
              -Effect
      of foreign currency translation
              
              
              -Allowance
      for inventory valuation at September 30, 2009 (Unaudited)
              
              
              -Additional
      reserves
              
              
              710,466Recovery
      of reserves
              
              
              -Increase
      in allowance from acquisition of Simo Motor
              
              
              8,186,252Effect
      of foreign currency translation
              
              
              145Allowance
      for inventory valuation at December 31, 2009
              
              
              8,896,863Additional
      reserves
              
              
              1,847,848Recovery
      of reserves
              
              
              (1,191,704
              )Decrease
      in allowance due to disposal of subdivisions
              
              
              (50,299
              )Effect
      of foreign currency translation
              
              
              194,182Allowance
      for inventory valuation at September 30, 2010 (Unaudited)
              
              $
              9,696,890
  - 20
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Note 8 – Advances on inventory
purchases
 
 The
Company makes advances to certain vendors for inventory
purchases.  The advances on inventory purchases were $13,578,174 and
$11,718,544 as of September 30, 2010 and December 31, 2009,
respectively.
 
 Note
9 – Plant and equipment, net
 
 The
following table presents details of our property and equipment:
 
 September
      30,
              
              
              December 31,2010
              
              
              2009(Unaudited)Buildings
              
              $
              89,299,364
              
              
              $
              88,081,895Office
      equipment
              
              
              2,653,496
              
              
              
              1,437,761Production
      equipment
              
              
              67,875,711
              
              
              
              28,801,414Vehicles
              
              
              2,812,889
              
              
              
              3,633,367Construction
      in progress
              
              
              49,867,132
              
              
              
              40,504,272Total
              
              
              212,508,592
              
              
              
              162,458,709Less:
      accumulated depreciation
              
              
              (11,783,436
              )
              
              
              (6,094,161
              )Property
      and equipment, net
              
              $
              200,725,156
              
              
              $
              156,364,548
 
 Construction
in progress represents labor costs, material, capitalized interest incurred in
connection with the construction of the new plant facility in Shanghai and the
construction and installation of manufacturing equipment in HTFE, Weihai and
Simo Motor.  The Company expects to complete the construction of
Shanghai plant on or before the end of year 2010.
 
 Depreciation
expense for the three months ended September 30, 2010 and 2009 amounted to
$2,372,722 and $655,509, respectively. Depreciation expense for the nine
months ended September 30, 2010 and 2009 amounted to $6,201,903, and $1,943,019,
respectively.
 
 For the
nine months ended September 30, 2010 and 2009, a total of $160,698 and
$2,971,471 of interest were capitalized into construction in progress,
respectively.
 
 Note
10 – Advances on non-current assets
 
 Advance for intangible
assets
 
 The
advances for intangible assets consisted of land use right prepayment. As of
September 30, 2010 and December 31, 2009, advances for intangible assets
amounted to $3,197,592 and $3,133,512, respectively.
  - 21
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 On
September 8, 2006, HTFE entered into an agreement ("Land Use Agreement") with
Shanghai Lingang Investment and Development Company Limited ("Shanghai Lingang")
with respect to HTFE’s use of 40,800 square meters of State-owned land in the
Shanghai Zhuqiao Airport Industrial Zone (the "Site").  The size of
the land used by HTFE was later revised to a total of approximately 53,000
square meters. The term of the land use agreement is 50 years and the
aggregate amount HTFE shall pay to Shanghai Lingang is approximately $6.28
million (RMB 42,840,000) ("Fee"), approximately 96.8% or $6.08 million (RMB
41,452,020) has been paid, as of September 30, 2010. HTFE shall register a
Sino-foreign joint venture company at the location of Shanghai Lingang, with
taxes payable at the same location. HTFE has agreed to compensate Shanghai
Lingang for certain local taxes due to the local tax authority in connection
with applicable tax generation requirements.
  Advance to
suppliers
 
 The
Company makes advances to certain vendors for equipments and construction
projects.  The advances on equipment and construction amounted to
$19,334,991 and $10,532,902 as of September 30, 2010 and December 31, 2009,
respectively.
 
 Note
11 – Goodwill and other intangible assets
 
 Net
intangible assets consist of the following at:
 
 September
      30,
                2010
              
              
              December
      31,
                2009(Unaudited)Goodwill
      on 2008 Acquisition of Weihai
              
              $
              12,273,778
              
              
              $
              12,273,778Goodwill
      on 2009 Acquisition of Simo Motor
              
              
              40,835,817
              
              
              
              41,799,976Total
      goodwill
              
              
              53,109,595
              
              
              
              54,073,754Land
      use rights
              
              
              18,089,963
              
              
              
              17,481,972Patents
              
              
              6,852,480
              
              
              
              6,702,983Software
              
              
              237,685
              
              
              
              95,110Intellectual
      property
              
              
              2,594,118
              
              
              
              -Customer
      lists
              
              
              288,235
              
              
              
              -Total
      goodwill and other intangible assets
              
              
              81,172,076
              
              
              
              78,353,819Less:
      accumulated amortization
              
              
              (4,726,391
              )
              
              
              (2,807,594
              )Intangible
      assets, net
              
              $
              76,445,685
              
              
              $
              75,546,225
 
 Amortization
expense for the three months ended September 30, 2010 and 2009 amounted to
$423,898 and $293,158, respectively. Amortization expense for the nine
months ended September 30, 2010 and 2009 amounted to $1,177,662 and $818,118,
respectively.
 
 The
Company uses the purchase method of accounting for business combinations. Annual
testing for impairment of goodwill is performed during the fourth quarter of
each year unless events or circumstances indicate earlier impairment testing is
required. No impairment loss was recognized for the three months and nine months
ended September 30, 2010 and 2009. As a result of the disposition of the three
subdivisions, effective April 1, 2010, Simo Motor no longer owns any of the
outstanding equity of Tianjin Simo, Science and Technology, and Imports and
Exports (see Note 3 for more discussion). Goodwill of these three subdivisions
in the amount of $964,159 was included in the carrying amount of the reporting
unit in determining the gain or loss on disposal.
 
 Goodwill,
      at the date of the acquisition of Simo Motor, (audited)
              
              $
              41,799,976Goodwill,
      disposed subsidiaries
              
              
              (964,159)Goodwill,
      as of September 30, 2010 (unaudited)
              
              $
              40,835,817
  - 22
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Note
12 – Taxes payable
 
 Taxes
payable consisted of the following:
  September
      30,
                2010
              
              
              December 31,
                2009(Unaudited)VAT
      tax payable
              
              $
              971,804
              
              
              $
              3,473,092Individual
      income tax withholding payable
              
              
              80,222
              
              
              
              71,563Corporation
      income tax payable
              
              
              2,940,585
              
              
              
              2,825,545Others
      miscellaneous tax payable
              
              
              2,586,299
              
              
              
              1,863,662Total
              
              $
              6,578,910
              
              
              $
              8,233,862
 
 Note
13 – Financing
 
 On August
29, 2006, the Company, Citadel Equity Fund Ltd. (“Citadel”) and Merrill Lynch
International (“Merrill Lynch” and, together with Citadel, the “Investors”)
entered into a purchase agreement (the “Purchase Agreement”) relating to the
purchase and sale of (a) $50 million aggregate principal amount of the Company's
Guaranteed Senior Secured Floating Rate Notes (collectively, the “Notes”) and
(b) fully detachable warrants (the “Warrants”) to purchase an aggregate of
3,487,368 shares of our common stock. The transaction closed on August 30,
2006.
 
 On June
1, 2009, the Company and Citadel entered into a Letter Agreement (the “Citadel
Agreement”). Pursuant to the Citadel Agreement, the Company was granted the
option to repurchase, all (but not part), of the $26.5 million 2012 Notes held
by Citadel before August 31, 2009 (“the Proposed 2012 Notes
Repurchase”).  On August 4, 2009, the Company notified Citadel
that pursuant to the Citadel Agreement (i) the Company was exercising its option
to consummate the Proposed 2012 Notes Repurchase and (ii) the Proposed 2012
Notes Repurchase shall be consummated on August 11, 2009 (the “Citadel
Repurchase Date”) at an aggregate Citadel Repurchase Price of $23,131,997 to be
paid in cash, which Repurchase Price shall be comprised of $22,525,000
representing 85% of the $26,500,000 aggregate principal amount of the 2012 Notes
held by Citadel (the “Citadel Notes”) plus $606,997 representing accrued
and unpaid interest on the Citadel Notes to but excluding the Repurchase Date.
On August 11, 2009, the Company made cash payment in accordance with terms of
the Citadel Agreement and recorded a gain of $3,975,000 from the repurchase
transaction.  After principal payment of $2,400,000 made in September 2009
and $3,800,000 made in March 2010, the 2012 Notes balance amounted to $5,083,486
(net of debt discount of $216,514), or a total of $5,300,000 was fully paid off
in September 2010.
 
 On July
14, 2009, the Company entered into a Letter Agreement with Merrill Lynch
International and ABN AMRO Bank N.V., London Branch (the “Merrill Agreement”).
Pursuant to the Merrill Agreement, the Company was granted the option to
repurchase, all (but not part),  of the remaining $6 million 2010
Notes held by Merrill Lynch International ($3 million) and ABN AMRO Bank N.V.,
London Branch  ($3 million) before July 31, 2009.  On July
31, 2009, the Company paid a total of $5,983,844 to repurchase the 2010
Notes, which amount was comprised of $5,820,000 representing 97% of the
$6,000,000 aggregate principal amount of the 2010 Notes held by the Holders plus
$163,844 representing accrued and unpaid interest on the 2010 Notes to but
excluding the Repurchase Date. As of August 5, 2009, the repurchase have been
completed and the 2010 Notes were cancelled and the Company recorded a gain of
$180,000 from the repurchase transaction.
 
 The
Warrants are governed by a warrant agreement, dated August 30, 2006, between AEM
and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year
warrants to purchase an aggregate of 2,192,308 shares of our common stock, at an
exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii)
six-year warrants to purchase an aggregate of 525,830 shares of our common stock
at an exercise price of $10.84 per share (the “Second Tranche 2012 Warrants”)
and (iii) three-year warrants to purchase an aggregate of 769,230 shares of our
common stock at an exercise price of $7.80 per share (the “2009
Warrants”).
  - 23
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  The First
Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to
Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
exercisable at the option of the Warrant holder at any time through the maturity
date of such Warrant. The warrant agreements contain a cashless exercise
provision.  During the three months and nine months ended September
30, 2010, no warrants were exercised.
 
 The fair
value of the warrants upon issuance totaled $22,921,113, was treated as a
discount on the carrying value of the debt, and is being amortized over the life
of the loan using the effective interest method. $216,514 and $8,207,689 were
amortized to interest expense for the three months ended September 30, 2010, and
2009, respectively. $1,439,790 and $10,215,337 were amortized to interest
expense for the nine months ended September 30, 2010, and 2009,
respectively.   As of September 30, 2010 and December 31, 2009, the
unamortized discounts totaled $0 and $1,439,790, respectively.
  Debt
issuance costs, initially $2,954,625, are carried in other assets and are
amortized over the life of the loan using the effective interest method. A
total of $77,319 and $900,836 were amortized to interest expense for the three
months ended September 30, 2010, and 2009, respectively. A total of
$359,255 and $1,172,056 were amortized to interest expense for the nine months
ended September 30, 2010 and 2009, respectively. As of September 30, 2010 and
December 31, 2009, unamortized debt issuance costs totaled $0 and $359,255,
respectively.
 
 Note
14 -Short term loans
 
 The
Company’s short term loans are comprised of the following:
 
 September
      30,
                2010
              
              
              December 31,
                2009(Unaudited)Short
      term loan – bank
              
              $
              31,589,694
              
              
              $
              38,291,634Short
      term loan – noncontrolling shareholders
              
              
              -
              
              
              
              918,342Short
      term loan – others
              
              
              21,287,213
              
              
              
              5,229,653Total
      short term loans
              
              $
              52,876,907
              
              
              $
              44,439,629
  - 24
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Short
term loans – bank
  September
      30,
                2010
              
              
              December 31,
                2009(Unaudited)Loan
      from Citic Bank in city of Wendeng, due June 2010. Monthly interest-only
      payments at 5.310% per annum, secured by assets
              
              $
              -
              
              
              $
              3,080,700Loan
      from Citic Bank in city of Wendeng, due May 2011. Monthly interest-only
      payments at 5.310% per annum, secured by assets
              
              
              3,143,700
              
              
              
              -Loan
      from Commercial Bank in city of Wendeng, due from various dates from
      August to September 2011. Monthly interest-only payments at 5.841% per
      annum, guaranteed loan
              
              
              1,197,600
              
              
              
              -Loan
      from Xi'an City Commercial Bank, due September 2010. Monthly interest-only
      payment at 5.31% per annum, guaranteed loan
              
              
              -
              
              
              
              1,173,600Loan
      From Huaxia Bank, due various dates from April to October 2010. Monthly
      interest-only payment at 6.480% per annum, secured by
      assets
              
              
              -
              
              
              
              8,802,000Loan
      From Industrial Commercial Bank of China, due December 2010. Monthly
      interest-only payment at 6.372% per annum, guaranteed
      loan
              
              
              1,559,874
              
              
              
              2,995,614Loan
      From Weihai City Commercial Bank, due various dates from August to
      September 2010. Monthly interest-only payment at 5.841% per annum, secured
      by assets
              
              
              -
              
              
              
              1,173,600Loan
      from Citic Bank, due in December 2010 through January 2011. Average
      interest from 5.310% per annum, secured by assets
              
              
              7,485,000
              
              
              
              6,161,400Loan
      from China Merchant Bank, due various dates from December 2010 to
      September 2011. Monthly interest-only payments from 5.310% to 5.346% per
      annum, secured by assets
              
              
              8,383,200
              
              
              
              8,215,200Loan
      from China Construction Bank, due in October 2010. Monthly interest-only
      payment at 10% per annum, guaranteed loan
              
              
              1,497,000
              
              
              
              1,467,000Loan
      from China Zheshang Bank, due in various dates from June to July 2010.
      Monthly interest-only payment at 5.841% per annum, guaranteed
      loan.
              
              
              -
              
              
              
              4,401,000Loan
      from Bank of China. Monthly interest-only payment at 4% per annum,
      unsecured, and due upon demand.
              
              
              838,320
              
              
              
              821,520Loan
      from Bank of Communications, due in June 2011.  Monthly interest-only
      payment at 5.841% per annum, guaranteed loan
              
              
              1,497,000
              
              
              
              -Loan
      from Huaxia Bank in city of Xi’an, due various dates from October 2010 to
      March 2011.  Interest-only payments at 6.48% per annum, secured
      by assets.
              
              
              5,988,000Short
      term loan - bank
              
              $
              31,589,694
              
              
              $
              38,291,634
  - 25
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Short
term loans – non controlling shareholders represent borrowing from its minority
shareholders and amounted to $0 and $918,342 as of September 30, 2010 and
December 31, 2009, respectively. All amounts are due within one year,
uncollaterized and the amount will be paid in the form of cash.
 
 The
Company has short term loans from sources other than banks amounted to
$21,287,213 and $5,229,653 as of September 30, 2010 and December 31, 2009.On July 28,
2010, the Company entered into a Loan Agreement, dated July 28, 2010 (the
“Agreement”) with Abax Emerald Ltd., a Cayman Islands limited company (“Abax”),
pursuant to which Abax agreed to provide the Company with up to $15,000,000 in
loans (the “Loan”). The Loan shall be made pursuant to one or more borrowings
(each, an “Advance”) from time to time from the Closing Date (July 28, 2010) to
the date falling on the expiration of five (5) months after the Closing Date
upon delivering a notice from us to Abax. In lieu of payment of interest in cash
on each Advance, the outstanding principal amount thereof shall accrete in value
for the period commencing on the Borrowing Date (the date on which any Advance
is made from us to Abax) for such Advance and ending on the day on which such
Advance is repaid, at a rate equal to 10% per annum, computed as described in
the Agreement. The Company may voluntarily prepay any Advance (or portion
thereof in an integral multiple of $100,000) at its accreted value at any time
upon written notice to Abax. On the Maturity Date (six months after the date of
the Agreement), the Company is obligated to repay the remaining outstanding loan
not theretofore paid, together with all fees and other amounts payable under the
Loan.
 
 The
Company’s long term bank loans as of September 30, 2010 and December 31, 2009
are as follows:
  September
      30,
                2010
              
              
              December 31,
                2009(Unaudited)Loan
      from Huaxia Bank in city of Xi’an, due various dates from February 2011 to
      March 2011.  Interest-only payments at 6.48% per annum, secured
      by assets.
              
              
              -
              
              
              
              4,401,000$
              
              
              
              $
              4,401,000
 
 The above
loans are secured by the Company's plants, buildings, land use rights and
inventories located within PRC, with carrying net value as follows:
  September
      30,
                2010
              
              
              December
      31,
                2009(Unaudited)Plant
      in Xi’an, Shaanxi, China
              
              $
              18,435,899
              
              
              $
              18,424,465Buildings
      in Xi’an and Weihai, China
              
              
              4,500,979
              
              
              
              6,037,376Land
      use rights in Xi’an and Weihai, China
              
              
              4,034,478
              
              
              
              4,742,161Inventories
      in Xi’an, Shaanxi, China
              
              
              8,982,000
              
              
              
              8,802,000Total
      assets pledged as collateral for bank loans
              
              $
              35,953,356
              
              
              $
              38,006,002
  Net
interest expense for the three months ended September 30, 2010 and 2009 was
comprised of the following (Unaudited):
 
 2010
              
              
              2009Amortization
      of debt discount
              
              $
              216,514
              
              
              $
              8,207,689Amortization
      of debt issuance costs
              
              
              77,319
              
              
              
              900,836Interest
      expense
              
              
              881,807
              
              
              
              54,335Interest
      earned on cash deposits
              
              
              (124,151
              )
              
              
              (251,887
              )Foreign
      currency transaction loss
              
              
              81,182
              
              
              
              (432,657
              )Interest
      expense, net
              
              $
              1,132,671
              
              
              $
              8,478,316
  - 26
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Net
interest expense for the nine months ended September 30, 2010 and 2009 was
comprised of the following (Unaudited):
 
 2010
              
              
              2009Amortization
      of debt discount
              
              $
              1,439,790
              
              
              $
              10,215,337Amortization
      of debt issuance costs
              
              
              359,255
              
              
              
              1,172,056Interest
      expense
              
              
              2,374,231
              
              
              
              226,319Interest
      earned on cash deposits
              
              
              (535,484
              )
              
              
              (623,517
              )Foreign
      currency transaction loss
              
              
              119,660
              
              
              
              (227,967
              )Interest
      expense, net
              
              $
              3,757,452
              
              
              $
              10,762,228
  Note
15 – Due to original shareholders
 
 Due to
original shareholders represent the amount that was unpaid for the acquisition
of Simo Motor and Wehai, which consisted of the following:
  September
      30,
                2010
              
              
              December 31,
                2009(Unaudited)Amount
      due to Simo Motor original shareholders
              
              $
              -
              
              
              $
              27,948,476Amount
      due to Weihai original shareholders
              
              
              748,500
              
              
              
              733,500$
              748,500
              
              
              $
              28,681,976
 
 The
amount due to Simo Motor original shareholders was paid in January 2010 in full.
Amount due to Weihai original shareholders is due on demand.
  Note
16 – Derivative instrument
 
 The
Company's operations are exposed to a variety of global market risks, including
the effect of changing currency exchange rates and interest rates. The Company
has used a financial derivative to manage these exposures in the past.
The Company uses financial derivatives only to hedge exposures in the ordinary
course of business and does not invest in derivative instruments for speculative
purposes.
 
 Effective
April 17, 2007, the Company entered into a cross currency interest rate swap
agreement with Merrill Lynch exchanging the LIBOR plus 3.35% variable rate
interest payable on the $38 million principle amount or 2012 Notes for a 7.2%
(3.6% semi-annually) RMB fixed rate interest.  The agreement required
semi-annual payments on March 1 and September 1 through the maturity of the
agreement on September 1, 2012.  Merrill Lynch required
the Company to deposit $1,000,000 with them to secure the
agreement.  The deposit may be increased to $2,500,000 if the exchange
rate for RMB to USD falls below 6.5, and to $4,000,000 if the exchange rate
falls below 5.5. This swap was designated and qualified as a cash flow
hedge. The fair value of this swap agreement at April 02, 2007 (inception
date) was a payable of $5,387,487, and on September 16, 2009 (the termination
date), was a payable of $9,003,322, respectively. Changes in the fair values of
derivative instruments accounted for as cash flow hedges, to the extent they
qualify for hedge accounting, are recorded in accumulated other comprehensive
income.   For the nine months ended September, 2009, the Company
recorded $3,237,042 as loss on the derivative instrument, respectively, in other
comprehensive income (loss).
 
 Effective
September 1, 2009, the whole original swap, with outstanding USD notional of
35,600,000 and outstanding CNY notional of 281,240,000 was unwound with a
$9,000,000 premium payment made to Merrill Lynch.  As a result,
$9,000,000 was transferred from the accumulated other comprehensive loss into
earnings as a loss from termination of the swap.  There were no
amounts recorded in the consolidated statements of income in relation to
ineffectiveness of this interest swap prior to unwind.
  - 27
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 During
the nine months ended September 30, 2009, the Company paid $1,299,764 as
hedging payment and the Company recognized $1,123,778 of loss from
derivative transactions.
 
 Changes
of cross currency hedge are as follows:
 
 Cross
      currency hedge payable balance at January 1,
    2009
              
              $
              175,986Proceeds
      from cross currency hedge
              
              
              -Loss
      from derivative transactions
              
              
              1,123,778Payments
      for cross currency hedge
              
              
              (1,299,764
              )Cross
      currency hedge payable balance at September 30, 2009
      (Unaudited)
              
              
              -Proceeds
      from cross currency hedge
              
              
              -Loss
      from derivative transactions
              
              
              -Payments
      for cross currency hedge
              
              
              -Cross
      currency hedge payable balance at December 31,
      2009
              
              
              -Proceeds
      from cross currency hedge
              
              
              -Loss
      from derivative transactions
              
              
              -Payments
      for cross currency hedge
              
              
              -Cross
      currency hedge payable balance at September 30, 2010
      (Unaudited)
              
              $
              -
 
 Note
17 – Additional product sales information
 
 The
Company has a single operating segment. The majority of the Company’s revenue
was generated from local sales.
 
 Summarized
financial information concerning the Company’s revenues based on geographic
areas for the three months ended September 30, 2010 and 2009 are as follows
(Unaudited):
   2010
              
              
              
              2009China
              
              $
              103,697,658
              
              
              $
              43,634,474International
              
              
              5,656,886
              
              
              
              3,297,557Total
      sales
              
              
              109,354,544
              
              
              
              46,932,031Cost
      of sales - China
              
              
              71,710,166
              
              
              
              28,331,369Cost
      of sales - International
              
              
              4,069,578
              
              
              
              1,839,428Total
      cost of sales
              
              
              75,779,744
              
              
              
              30,170,797Gross
      profit
              
              $
              33,574,800
              
              
              $
              16,761,234
 
 Summarized
financial information concerning the Company’s revenues based on geographic
areas for the nine months ended September 30, 2010 and 2009 are as follows
(Unaudited):
   2010
              
              
              
              2009China
              
              $
              301,954,734
              
              
              $
              105,879,950International
              
              
              18,320,937
              
              
              
              10,141,458Total
      sales
              
              
              320,275,671
              
              
              
              116,020,408Cost
      of sales - China
              
              
              203,749,661
              
              
              
              69,776,860Cost
      of sales - International
              
              
              11,876,953
              
              
              
              5,695,260Total
      cost of sales
              
              
              215,626,614
              
              
              
              75,472,120Gross
      profit
              
              $
              104,649,057
              
              
              $
              40,548,288
  - 28
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  The
following table presents the revenue contribution by each major product
line in the three months and nine months ended September 30, 2010 and 2009
(unaudited):
   Three Months Ended September 30Product Line
              
              2010
              
              
              2009Sales
      by product line:Linear
      Motors and Related Systems
              
              $
              19,329,721
              
              
              $
              16,417,033Specialty
      Micro-Motors
              
              
              15,305,526
              
              
              
              8,446,353Rotary
      MotorsWeihai
              
              
              23,499,055
              
              
              
              20,677,183Xi’an
              
              
              48,932,196
              
              
              
              -Others
              
              
              2,288,046
              
              
              
              1,391,462Total
      sales
              
              
              109,354,544
              
              
              
              46,932,031Cost
      of sales:Linear
      Motors and Related Systems
              
              
              7,127,884
              
              
              
              6,225,992Specialty
      Micro-Motors
              
              
              10,484,525
              
              
              
              5,030,871Rotary
      MotorsWeihai
              
              
              20,933,253
              
              
              
              18,243,208Xi’an
              
              
              35,841,911
              
              
              
              -Others
              
              
              1,392,171
              
              
              
              670,726Total
      cost of sales
              
              
              75,779,744
              
              
              
              30,170,797Gross
      profit
              
              $
              33,574,800
              
              
              $
              16,761,234
  Nine Months Ended September 30Product Line
              
              2010
              
              
              2009Sales
      by product line:Linear
      Motors and Related Systems
              
              $
              59,339,909
              
              
              $
              40,276,281Specialty
      Micro-Motors
              
              
              46,675,006
              
              
              
              23,094,729Rotary
      MotorsWeihai
              
              
              69,533,181
              
              
              
              48,519,410Xi’an
              
              
              138,510,802
              
              
              
              -Others
              
              
              6,216,773
              
              
              
              4,129,988Total
      sales
              
              
              320,275,671
              
              
              
              116,020,408Cost
      of sales:Linear
      Motors and Related Systems
              
              
              23,045,614
              
              
              
              16,862,261Specialty
      Micro-Motors
              
              
              30,087,527
              
              
              
              13,794,215Rotary
      MotorsWeihai
              
              
              61,345,452
              
              
              
              42,750,268Xi’an
              
              
              97,268,784
              
              
              
              -Others
              
              
              3,879,237
              
              
              
              2,065,376Total
      cost of sales
              
              
              215,626,614
              
              
              
              75,472,120Gross
      profit
              
              $
              104,649,057
              
              
              $
              40,548,288
 
 - 29
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Note
18 – Business combinations
 
 Acquisition of
Xi’an Tech Full Simo Motor
Co. Ltd.
  On
October 2, 2009, HTFE entered into an Equity Acquisition Agreement (the
“Agreement”) with Xi’an Simo Electric Co. Ltd. (“Xi’an Simo”) and Shaanxi
Electric Machinery Association (“Shaanxi Electric” and collectively with Xi’an
Simo, the “Selling Shareholders”) whereby HTFE agreed to acquire (i) 100% of the
outstanding shares of Simo Motor, which was 99.94% owned by Xi’an Simo and 0.06%
owned by Shaanxi Electric, and (ii) all corresponding assets of Simo Motor,
including but not limited to, all of the manufacturing equipment, real-estate,
land use rights, stocks, raw materials, automobiles, intellectual property,
receivables, other receivables, payables, business contracts and external
investments owned by Simo Motor for an aggregate price of approximately $111.6
million (RMB 763.2 million), payable in cash.  The acquisition
also included 15 wholly-owned and 8 majority-owned subsidiaries by Simo Motor.
As a result, the Company’s ownership to Simo Motor and all subsidiaries averaged
to 87.2%. The remaining 12.8% was owned by noncontrolling shareholders. On
October 13, 2009, the Company completed the acquisition of Simo Motor. As of the
closing date, HTFE had completed the registration of the share transfer with the
requisite PRC authorities and had obtained the required business registration
and transfer of licenses of Simo Motor, all as contemplated by the Agreement. On
October 13, 2009, Simo Motor changed its name to Xi’an Tech Full Simo Motor
Co. Ltd.
 
 The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition:
  Net Book Value
              
              
              Fair ValueCash
      and cash equivalents
              
              $
              11,092,963
              
              
              $
              11,092,963Restricted
      cash
              
              
              15,641
              
              
              
              15,641Accounts
      receivable, net
              
              
              61,945,058
              
              
              
              61,945,058Inventories
              
              
              65,133,441
              
              
              
              65,133,441Advances
      on inventory purchases
              
              
              8,036,296
              
              
              
              8,036,296Other
      assets, current
              
              
              4,695,563
              
              
              
              4,695,563Current
      assets
              
              
              150,918,962
              
              
              
              150,918,962Property,
      plant and equipment, net
              
              
              53,417,013
              
              
              
              54,331,338Intangible
      assets
              
              
              5,919,862
              
              
              
              13,146,349Other
      noncurrent assets
              
              
              970,465
              
              
              
              970,465Goodwill
              
              
              -
              
              
              
              41,799,976Total
      assets
              
              
              211,226,302
              
              
              
              261,167,090Accounts
      payable
              
              
              42,156,368
              
              
              
              42,156,368Short
      term loan – bank and others
              
              
              44,088,679
              
              
              
              44,088,679Customer
      deposits
              
              
              21,264,239
              
              
              
              21,264,239Tax
      payable
              
              
              6,825,557
              
              
              
              6,825,557Accrued
      liabilities and other liabilities, current
              
              
              11,047,957
              
              
              
              11,047,957Long
      term loan, bank
              
              
              5,868,000
              
              
              
              5,868,000Total
      liabilities
              
              
              131,250,800
              
              
              
              131,250,800Noncontrolling
      interest
              
              
              17,957,814
              
              
              
              17,957,814Net
      assets
              
              $
              62,017,688
              
              
              $
              111,958,476
 
 The
Company accounts for business combinations using the purchase method of
accounting. The total consideration paid in an acquisition is allocated to the
fair value of the acquired company’s identifiable assets and liabilities. Any
excess of the purchase price over the estimated fair values of the net assets
acquired is recorded as goodwill. The goodwill recognized in conjunction
with the acquisition of Simo Motor in October 2009 represents intangible values
that Simo has built over its more than 40 years of history, which do not qualify
for separate recognitions, or other factors. These values include but are not
limited to:
  (i)
                Expected
      synergies from combining operations of Simo and
  Harbin;
  - 30
-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 
 (ii)
              The
      experienced work force;
 
 (iii)
              Thousands
      of product models and related proprietary technologies;
  and
 
 (iv)
              The
      proprietary manufacturing
processes.
 
 Effective
April 1, 2010, as a result of the disposition of the three subdivisions, Simo
Motor would no longer own any of the outstanding equity of Tianjin Simo, Science
and Technology, Imports and Exports (see Note 3 for more discussion). Goodwill
of these three subdivisions in the amount of $964,159 was included in the
carrying amount of the reporting unit in determining the gain or loss on
disposal.
  Goodwill,
      at the date of the acquisition of Simo Motor, (audited)
              
              $
              41,799,976Goodwill,
      disposed subsidiaries
              
              
              (964,159)Goodwill,
      as of September 30, 2010 (unaudited)
              
              $
              40,835,817
 
 For the
above acquisition, the acquirer, HTFE and the acquired subsidiaries of the
Company, engaged a third party independent appraiser to evaluate and determine
the fair value of major assets acquired. The third party independent appraiser
is a certified public accountant under the laws of PRC (the “PRC CPA”). The
assets evaluated by the independent appraiser included fixed assets (equipment
and buildings), construction in progress, and intangible assets (land use
rights).  The PRC CPA conducted an on-site visit, inspected each item,
conducted market research and investigation and provided an evaluation report
based on certain asset evaluation policies and regulations issued by the Chinese
government. The Company’s management used the PRC CPA’s appraisal reports as a
reference to assess the fair value of these assets and reported in the financial
statements. For current assets, however, the management used the carrying value
on the acquisition date.
  Pro
Forma
 
 The
following unaudited pro forma condensed income statement for the three months
and nine months ended September 30, 2010 and 2009 were prepared under generally
accepted accounting principles, as if the acquisition of Simo Motor had occurred
the first day of the respective periods. The pro forma information may not be
indicative of the results that actually would have occurred if the acquisition
had been in effect from and on the date indicated.
  For the three
      months ended September 30 (Unaudited),
              
              2010
              
              
              2009Sales
              
              $
              109,354,544
              
              
              $
              100,747,561Cost
      of Goods Sold
              
              
              75,779,744
              
              
              
              72,294,967Gross
      Profit
              
              
              33,574,800
              
              
              
              28,452,594Operating
      Expenses
              
              
              11,722,195
              
              
              
              8,716,110Income
      from Operations
              
              $
              21,852,605
              
              
              $
              19,736,484Other
      expense, net
              
              
              694,749
              
              
              
              15,214,696Income
      Tax
              
              
              3,296,165
              
              
              
              3,512,450Net
      Income before noncontrolling interest
              
              $
              17,861,691
              
              
              $
              1,009,338Net
      Income attributable to controlling interest
              
              $
              17,872,932
              
              
              $
              (1,347,005
              )
  - 31
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  For the nine
      months ended September 30 (Unaudited),
              
              2010
              
              
              2009Sales
              
              $
              320,275,671
              
              
              $
              241,842,043Cost
      of Goods Sold
              
              
              215,626,614
              
              
              
              168,015,718Gross
      Profit
              
              
              104,649,057
              
              
              
              73,826,325Operating
      Expenses
              
              
              26,981,985
              
              
              
              23,325,270Income
      from Operations
              
              $
              77,667,072
              
              
              $
              50,501,055Other
      expense, net
              
              
              73,348
              
              
              
              27,816,780Income
      Tax
              
              
              11,150,418
              
              
              
              7,350,129Net
      Income before noncontrolling interest
              
              $
              66,443,306
              
              
              $
              15,334,146Net
      Income attributable to controlling interest
              
              $
              64,101,424
              
              
              $
              10,105,829
 
 Note
19 – Commitments and contingencies
 
 Commitments
 
 The
Company enters into non-cancelable purchase commitments with some of its
vendors. As of September 30, 2010 and December 31, 2009, the Company was
obligated under the non-cancelable commitments to purchase materials totaling to
$584,064 and $456,174, respectively. These commitments are short-term and expire
within one year. The Company has not experienced losses on these purchase
commitments over the years.
 
 On August
25, 2010, the Company entered into an agreement with Shelton Technology,
LLC.  Under the terms of the agreement, the Company is required to
contribute a total of $1 million to AAG prior to December 31, 2011.
 
 On
September 8, 2006, HTFE entered into an agreement (“Land Use Agreement”) with
Shanghai Lingang Investment and Development Company Limited (“Shanghai Lingang”)
with respect to HTFE’s lease and use of 40,800 square meters of State-owned land
in the Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The size of
the land used by HTFE was later revised to a total of approximately 53,000
square meters. The term of the Land Use Agreement is 50 years and totaled $6.28
million (RMB 42.84 million) (“Fee”), approximately 96.8% or $6.08 million (RMB
41,452,020) of which has been paid with the balance to be paid in
installments.
 
 Contingencies
 
 Ten
punitive shareholder class action complaints have been filed against Harbin
and/or certain officers and directors thereof in connection with the October 10,
2010 non-binding proposal made by Mr. Tianfu Yang and Baring for Mr. Yang and
the Baring Fund to acquire all of the outstanding shares of Common Stock of
Harbin not currently owned by Mr. Yang and his affiliates in a going private
transaction for $24.00 per share in cash, subject to certain conditions (the
“Yang Proposal”). In each complaint, the plaintiffs challenge the Yang Proposal
and allege, among other things, that the consideration to be paid in such
proposal is unfair and inadequate. The complaints seek, among other relief, to
enjoin defendants from consummating the Yang Proposal and to direct defendants
to exercise their fiduciary duties to obtain a transaction that is in the best
interests of the Company’s shareholders.  Seven of these complaints
were filed in the State of Nevada, and the remaining complaints were filed in
the State of New York. The Company reviewed the allegations contained in the
various complaints and believed they are without merit and intended to defend
the litigation vigorously. As such, based on the information known to us to
date, we do not believe that it is probable that a material judgment against us
will result. In accordance with ASC Topic 450, no liability has been
accrued.
  - 32
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Guarantee
of Third-Party Indebtedness –No Liability Is
Recorded
  As of
September 30, 2010, the Company guaranteed bank loans for third parties’ bank
loans, amounting to $9,281,400.
 
 Nature
      ofguarantee
              
              Guaranteeamount
              
              Guaranty
      periodBank
      loans
              
              
              9,281,400
              
              Various
      from January 2010 to April 2011Total
              
              $
              9,281,400
 
 The
Company has evaluated the guarantee and concluded that the likelihood of having
to make payments under the guarantee is remote.
 
 Note
20 – Earnings per share
 
 FASB
requires presentation of basic and diluted earnings per share in conjunction
with the disclosure of the methodology used in computing such earnings per
share.  Basic earnings per share excludes dilution and is computed by
dividing income available to common stockholders by the weighted average common
shares outstanding during the period. Diluted earnings per share takes into
account the potential dilution that could occur if securities or other contracts
to issue common stock were exercised and converted into common stock. The
following is a reconciliation of the basic and diluted earnings per share
computations:
 
 For
      the three months ended September 30,2010
              
              
              2009(Unaudited)Net
      income before noncontrolling interest
              
              
              17,861,691
              
              
              
              (1,907,964
              )Less:
      Net income attributable to noncontrolling interest
              
              
              (11,241)
              
              
              
              -Net
      income attributable to controlling interest
              
              $
              17,872,932
              
              
              $
              (1,907,964
              )Weighted
      average shares used in basic computation
              
              
              31,067,471
              
              
              
              27,076,669Diluted
      effect of stock options and warrants
              
              
              214,331
              
              
              
              -Weighted
      average shares used in diluted computation
              
              
              31,281,802
              
              
              
              27,076,669
 Earnings
      per share - Basic:Net
      income before noncontrolling interest
              
              $
              0.57
              
              
              $
              (0.07
              )Less:
      Net income attributable to noncontrolling interest
              
              $
              0.01
              
              
              $
              -Net
      income attributable to controlling interest
              
              $
              0.58
              
              
              $
              (0.07
              )Earnings
      per share - Diluted:Net
      income before noncontrolling interest
              
              $
              0.57
              
              
              $
              (0.07
              )Less:
      Net income attributable to noncontrolling interest
              
              $
              -
              
              
              $
              -Net
      income attributable to controlling interest
              
              $
              0.57
              
              
              $
              (0.07
              )
  - 33
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  For
      the nine months ended September 30,2010
              
              
              2009(Unaudited)Net
      income before noncontrolling interest
              
              
              66,443,306
              
              
              
              1,327,006Less:
      Net income attributable to noncontrolling interest
              
              
              2,341,882
              
              
              
              -Net
      income attributable to controlling interest
              
              $
              64,101,424
              
              
              $
              1,327,006Weighted
      average shares used in basic computation
              
              
              31,067,471
              
              
              
              23,861,950Diluted
      effect of stock options and warrants
              
              
              260,292
              
              
              
              162,222Weighted
      average shares used in diluted computation
              
              
              31,327,763
              
              
              
              24,024,172
 Earnings
      per share - Basic:Net
      income before noncontrolling interest
              
              $
              2.14
              
              
              $
              0.06Less:
      Net income attributable to noncontrolling interest
              
              $
              (0.08
              )
              
              $
              -Net
      income attributable to controlling interest
              
              $
              2.06
              
              
              $
              0.06Earnings
      per share - Diluted:Net
      income before noncontrolling interest
              
              $
              2.12
              
              
              $
              0.06Less:
      Net income attributable to noncontrolling interest
              
              $
              (0.07
              )
              
              $
              -Net
      income attributable to controlling interest
              
              $
              2.05
              
              
              $
              0.06
 
 Except
for 30,000 stock options at $20.02 per share, all stock options and warrants
have been included in the diluted earnings per share calculation for the nine
and three months ended September 30, 2010 and 2009.
 
 Note
21 – Shareholders’ equity
 
 Statutory
reserves
 
 The laws
and regulations of the People’s Republic of China require that before a
Sino-foreign cooperative joint venture enterprise distributes profits to its
partners, it must first satisfy all tax liabilities, provide for losses in
previous years, and make allocations in proportions determined at the discretion
of the board of directors, after the statutory reserve.
 
 Surplus reserve
fund
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital. The transfer to this reserve must be made before distribution of
any dividend to shareholders. The Company will transfer at year end 10% of the
year’s net income determined in accordance with PRC accounting rules and
regulations.
 
 For the
nine months ended September 30 2010 and 2009, the Company transferred $5,263,046
and $3,326,666, respectively, representing 10% of the net income generated by
the Company’s subsidiaries located within PRC determined in accordance with PRC
accounting rules and regulations, to this reserve. The remaining reserve to
fulfill the 50% registered capital requirement amounted to approximately $46.3
million and $49.7 million as of September 30, 2010 and December 31, 2009,
respectively.
 
 The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years’ losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issue is not less than 25% of the registered
capital.
  - 34
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Warrants
 
 Following
is a summary of warrant activity:
 
 Outstanding
      as of January 1, 2009
              
              
              2,030,158Granted
              
              
              -Forfeited
              
              
              -Exercised
              
              
              (1,663,461)Outstanding
      as of September 30, 2009 (Unaudited)
              
              
              366,697Granted
              
              
              -Forfeited
              
              
              -Exercised
              
              
              -Outstanding
      as of December 31, 2009
              
              
              366,697Granted
              
              
              -Forfeited
              
              
              -Exercised
              
              
              -Outstanding
      as of September 30, 2010 (Unaudited)
              
              
              366,697
 
 Following
is a summary of the status of warrants outstanding at September 30,
2010:
  Outstanding Warrants
              
              
              Exercisable WarrantsExercise
      Price
              
              
              Number of
                Shares
              
              
              Average
                Remaining
                Contractual
                Life
              
              
              Average
                Exercise Price
              
              
              Number of
                Shares
              
              
              Average
                Remaining
                Contractual
                Life$
              10.84
              
              
              
              366,697
              
              
              
              1.92
              
              
              $
              10.84
              
              
              
              366,697
              
              
              
              1.92Total
              
              
              
              366,697
              
              
              
              
              
              
              
              
              
              
              
              366,697
 
 Options
 
 On
November 30, 2009, the Company granted options to an independent director to
purchase an aggregate of 30,000 shares of the Company's common stock, at an
exercise price of $20.02 per share, the closing price of the Company’ s common
stock on November 30, 2009. The fair values of stock options granted to
employees and the independent directors were estimated at the date of grant
using the Black-Scholes option-pricing model with the following
assumptions:
  ExpectedLife
              
              ExpectedVolatility
              
              
              DividendYield
              
              
              Risk
      FreeInterest
      Rate
              
              
              Exercise
      PriceEmployees
      - 2006
              
              5.0
      yrs
              
              
              66
              %
              
              
              0
              %
              
              
              4.13
              %
              
              $
              8.10Directors
      - 2006
              
              5.0
      yrs
              
              
              66
              %
              
              
              0
              %
              
              
              4.13
              %
              
              $
              8.10Executives
      - 2007
              
              3.0
      yrs
              
              
              77
              %
              
              
              0
              %
              
              
              4.50
              %
              
              $
              15.60Directors
      - 2009
              
              3.0
      yrs
              
              
              70
              %
              
              
              0
              %
              
              
              1.15
              %
              
              $
              20.02
  - 35
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
  Following
is a summary of stock option activity:
  Options
                Outstanding
              
              
              Weighted
                Average
                Exercise Price
              
              
              Aggregate Intrinsic
                ValueOutstanding
      as of December 31, 2008
              
              
              694,583
              
              
              $
              10.27
              
              
              $
              -Granted
              
              
              -
              
              
              
              -
              
              
              
              -Forfeited
              
              
              (25,000
              )
              
              
              12.40
              
              
              
              -Exercised
              
              
              -
              
              
              
              -
              
              
              
              -Outstanding
      as of September 30, 2009 (Unaudited)
              
              
              669,583
              
              
              $
              10.19
              
              
              $
              4,479,510Granted
              
              
              30,000
              
              
              
              20.02
              
              
              
              -Forfeited
              
              
              -
              
              
              
              -
              
              
              
              -Exercised
              
              
              (344,583
              )
              
              
              7.15
              
              
              
              -Outstanding
      as of December 31, 2009
              
              
              355,000
              
              
              $
              13.97
              
              
              $
              2,333,600Granted
              
              
              -
              
              
              
              -
              
              
              
              -Forfeited
              
              
              -
              
              
              
              -
              
              
              
              -Exercised
              
              
              -
              
              
              
              -
              
              
              
              -Outstanding
      as of September 30, 2010 (Unaudited)
              
              
              355,000
              
              
              $
              13.97
              
              
              $
              1,391,600
  - 36
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Following
is a summary of the status of options outstanding at September 30,
2010:
 
 Outstanding Options
              
              
              Exercisable OptionsExercise
      Price
              
              
              Number
              
              
              Average Remaining
      Contractual Life
              
              
              Average
                Exercise Price
              
              
              Number
              
              
              Average Remaining
      Contractual Life$
              8.10
              
              
              
              95,000
              
              
              
              0.35
              
              
              $
              8.10
              
              
              
              95,000
              
              
              
              0.35$
              15.60
              
              
              
              230,000
              
              
              
              0.20
              
              
              $
              15.60
              
              
              
              195,333
              
              
              
              0.20$
              20.02
              
              
              
              30,000
              
              
              
              4.17
              
              
              $
              20.02
              
              
              
              18,750
              
              
              
              4.17Total
              
              
              
              355,000
              
              
              
              
              
              
              
              
              
              
              
              309,083
  On July
12, 2007, the Company’s CEO transferred 280,000 of his own shares to the Company
employees and consultants. The shares vest over 5 to 10 years starting July 12,
2007. The Company valued the shares at $13.73 per share, based on the average
price for the immediately preceding fifteen consecutive trading days before June
16, 2007, the date when the Company and HTFE entered into the asset purchase
agreement with Harbin Taifu Auto Electric Co., Ltd., the trading price of the
stock on the date of transfer, as a capital contribution totaling $3,844,904 by
the CEO, the value was amortized over the vesting
period.
  For the
three months ended September 30, 2010 and 2009, stock compensation expense
related to options issued amounted to $254,668, and $242,928,
respectively. For the nine months ended September 30, 2010 and 2009, stock
compensation expense related to options issued amounted to $764,006, and
$827,218, respectively.
  Note 22 –
Employee pension
 
 Regulations
in the People’s Republic of China require the Company to contribute to a defined
contribution retirement plan for all employees. All Joint Venture employees are
entitled to a retirement pension amount calculated based upon their salary at
their date of retirement and their length of service in accordance with a
government managed pension plan. The PRC government is responsible for the
pension liability to the retired staff. The employee pension in Harbin generally
includes two parts: the first part to be paid by the Company is 20% of the
employees’ actual salary in the prior year. If the average salary falls
below $1,165 for each individual, $1,165 will be used as the basis. The Company
made contributions to employment benefits, including pension, of $973,762, and
$107,965 for the three months ended September 30, 2010 and 2009,
respectively. The Company made contributions to employment benefits,
including pension, of $2,275,221, and $277,638 for the nine months ended
September 30, 2010 and 2009, respectively. The other part, paid by the
employees, is 8% of actual salary with the same minimum
requirement.
  - 37
-
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2010
 (UNAUDITED)
 Note 23 –
Subsequent events
 
 On
October 10, 2010, our Board of Directors received a proposal from Mr. Tianfu
Yang (“Mr. Yang”) and Baring Private Equity Asia Group Limited (“Baring”) for
Mr. Yang and an investment fund advised by Baring (the "Baring Fund") to acquire
all of the outstanding shares of Common Stock of Harbin Electric not currently
owned by Mr. Yang and his affiliates in a going private transaction for $24.00
per share in cash, subject to certain conditions. Mr. Yang owns 31.1% of our
Common Stock. According to the proposal letter, Mr. Yang and Baring intend to
form an acquisition vehicle for the purpose of completing the acquisition and
that they intend to finance the acquisition with a combination of debt and
equity capital.  The proposal letter states that Goldman Sachs (Asia)
LLC (“Goldman”) is acting as financial advisor to the acquisition vehicle to be
formed by Mr. Yang and Baring and that Goldman has informed Mr. Yang and Baring
that it is highly confident that the underwriting and arranging of commitments
for the debt financing needed to complete the transaction can be done. The
proposal letter states that the equity portion of the financing would be
provided by Mr. Yang, the Baring Fund and related sources. Our Board of
Directors has formed a special committee of independent directors to evaluate
and consider this proposal. There can be no assurance that any definitive offer
will be made, that any agreement will be executed or that this or any other
transaction will be approved or consummated. See Part II, Item 1A. “Risk
Factors” of this Quarterly Report on Form 10-Q.
 
 In
October 2010, a total of 183,349 Second Tranche 2012 Warrant was exercised and
the Company received $1,987,503 in cash for the warrant exercise pursuant to the
terms of the Warrant.
 
 The
Company has performed an evaluation of subsequent events through the date these
consolidated financial statements were issued to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions in the consolidated financial statements as of September 30,
2010.
  -
38 -




Item 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations




INFORMATION
REGARDING FORWARD LOOKING STATEMENTS





The
following is management’s discussion and analysis of certain significant factors
that have affected aspects of our financial position and results of operations
during the periods included in the accompanying unaudited financial statements.
You should read this in conjunction with the discussion under “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
the audited financial statements for the year ended December 31, 2009
included in our Annual Report on Form 10-K and the unaudited consolidated
financial statements and notes thereto set forth in Item 1 of this Quarterly
Report. In addition to historical information, this discussion and analysis
contains forward-looking statements that relate to future events and
expectations and, as such, constitute forward-looking statements.
Forward-looking statements include those containing such words as “anticipates,”
“believes,” “estimates,” “expects,” “hopes,” “targets,” “should,” “will,” “will
likely result,” “forecast,” “outlook,” “projects” or similar expressions.
Such forward-looking statements involve known and unknown risks, uncertainties,
and other factors that may cause actual results, performance or achievements of
the Company to be materially different from those expressed or implied in the
forward-looking statements.




OVERVIEW




Harbin
Electric, Inc. (“Harbin Electric” or the “Company”) is incorporated under the
laws of the state of Nevada and, along with our wholly-owned subsidiaries, is
headquartered in Harbin, China. We design, develop, manufacture, supply, and
service a wide range of electric motors, with a focus on innovation, creativity,
and value-added products. Our major product lines include linear motors,
specialty micro-motors, and industrial rotary motors. Our products are purchased
by a broad range of customers including those customers in the energy industry,
factory automation, food processing, packaging industry, power generation
systems, mass transportation and freight transportation systems, chemical,
petrochemical, metallurgical, mining, textile, agricultural, and machinery
industries. We primarily supply domestic markets in China and also certain
international markets.




We
currently operate the following four manufacturing facilities in China with an
employee base of approximately 5,270 engineers, production technicians, and
other employees:






            Harbin
      Tech Full Electric Co., Ltd. (“Harbin Tech Full”) is located in the
      government-designated Development Zone in the city of Harbin with
      approximately 50,000 square meters of land and manufactures linear motors
      and linear motor integrated
systems.






            Shanghai
      Tech Full Electric Co., Ltd. (“Shanghai Tech Full”) is located in the
      Shanghai Zhuqiao Airport Industrial Zone with 40,800 square meters of land
      and manufactures specialty
micro-motors.






            Weihai
      Tech Full Simo Motor Co., Ltd. (“Weihai Tech Full Simo”) is located in
      Weihai with approximately 150,000 square meters of land and primarily
      manufactures small to medium sized industrial rotary
    motors.






            Xi’an
      Tech Full Simo Motor Co., Ltd. (“Xi’an Tech Full Simo”) was acquired in
      October 2009 and manufactures primarily medium to large sized industrial
      rotary motors. Xi’an Tech Full Simo is located in Xi’an city’s Economy and
      Technology Development Zone and occupies approximately 200,000 square
      meters of land.




We are
subject to risks common to companies operating in China, including risks
inherent in our distribution and commercialization efforts, uncertainty of
foreign regulatory and marketing approvals and laws, reliance on key customers,
enforcement of patent and proprietary rights, the need for future capital, and
retention of key employees. We cannot provide assurance that we will generate
revenues or achieve and sustain profitability in the future.





RECENT
EVENTS





On
October 10, 2010, our Board of Directors received a non-binding proposal from
Mr. Tianfu Yang (“Mr. Yang”) and Baring Private Equity Asia Group Limited
(“Baring”) for Mr. Yang and an investment fund advised by Baring (the "Baring
Fund") to acquire all of the outstanding shares of Common Stock of Harbin
Electric not currently owned by Mr. Yang and his affiliates for $24.00 per share
in cash, subject to certain conditions. Mr. Yang owns 31.1% of our Common Stock.
According to the proposal letter, Mr. Yang and Baring intend to form an
acquisition vehicle for the purpose of completing the acquisition and that they
intend to finance the acquisition with a combination of debt and equity
capital.  The proposal letter states that Goldman Sachs (Asia) LLC
(“Goldman”) is acting as financial advisor to the acquisition vehicle to be
formed by Mr. Yang and Baring and that Goldman has informed Mr. Yang and Baring
that it is highly confident that the underwriting and arranging of commitments
for the debt financing needed to complete the transaction can be done. The
proposal letter states that the equity portion of the financing would be
provided by Mr. Yang, the Baring Fund and related sources.  Our Board
of Directors has formed a special committee of independent directors to evaluate
and consider this proposal. There can be no assurance that any definitive
offer will be made, that any agreement will be executed or that this or any
other transaction will be approved or consummated. See Part II, Item 1A. “Risk
Factors” of this Quarterly Report on Form 10-Q.





- 39
-




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES





We
believe that the application of the following accounting policies, which are
important to our financial position and results of operations, require
significant judgments and estimates on the part of management. Our critical
accounting policies and estimates present an analysis of the uncertainties
involved in applying a principle, while the accounting policies note to the
financial statements (Note 2) describes the method used to apply the accounting
principle.





Accounts
Receivable





Accounts
receivable are presented net of an allowance for bad debts account. The Company
maintains reserves for potential credit losses on accounts receivable.
Management reviews the composition of accounts receivable and analyzes
historical bad debts, customer concentrations, customer credit worthiness,
current economic trends, and changes in customer payment patterns to evaluate
the adequacy of these reserves. The estimated loss rate is based on
our historical loss experience and also considerations of current market
conditions. Delinquent account balances are written-off after management has
determined that the likelihood of collection is not probable, and known bad
debts are written off against allowance for doubtful accounts when
identified.




Inventories





Inventories
are valued at the lower of cost or market value, as determined on a first-in,
first-out basis, using the weighted average method. Management compares the cost
of inventories with the market value and an allowance is made for writing down
the inventory to its market value, if lower than cost. On an ongoing basis,
inventories are reviewed for potential write-down for estimated obsolescence or
unmarketable inventories equal to the difference between the costs of
inventories and the estimated net realizable value based upon forecasts for
future demand and market conditions. When inventories are written-down to
the lower of cost or market, it is not marked up subsequently based on changes
in underlying facts and circumstances.  Inventories are composed
of raw material for manufacturing electrical motors, work in process, and
finished goods within the Company’s warehouse premise or consigned at a customer
site.





Revenue
Recognition




The
Company recognizes sales at the date of shipment to customers when a formal
arrangement exists, the price is fixed or determinable, the delivery is
completed, no other significant obligations of the Company exist and
collectability is reasonably assured. For products that are required to be
examined by customers, sales revenue is recognized after the customer
examination is passed. Payments received before all of the relevant criteria for
revenue recognition are recorded as customer deposits.





In
addition, revenue recognition could be negatively impacted by returns. For our
linear motor and specialty micro-motor businesses, our products are custom
products which are customer specific, and no returns are allowed. We warrant our
product for repair, only in the event of defects for two years from the date of
shipment.  We charge such costs to cost of goods sold. For our
industrial rotary motor business, our products are standardized products and
returns are allowed within three days upon receipt of products by customers. We
provide product warranty for repair one year from the date of shipment.
Historically, the returns and defects have not been material. Should returns
increase in the future it would be necessary to adjust the estimates, in which
case recognition of revenues could be delayed.





The
Company also provides after-sale services to our customers. Service revenue is
recognized as services are rendered, the customers have approved the completion
of the services and invoices have been issued and collectability is reasonably
assured. Customer billings for services not yet rendered are deferred and
recognized as revenue as the services are rendered and the associated deferred
revenue is included in current liabilities or long-term liabilities, as
appropriate.





The
Company recognizes revenues with regards to the sales of consigned inventories
when the title and risks of ownership have been transferred to customers;
customers provide a persuasive evidence to notify the Company, and upon receipt
of the notification form from customers. The Company also performs periodic
inventory counts to confirm the inventory quantities held on
consignment.





Stock-Based
Compensation




We record
share-based compensation expense based upon the grant date fair value of
share-based awards. The value of the award is principally recognized as expense
ratably over the requisite service periods. We use the Black-Scholes Merton
(“BSM”) option-pricing model, which incorporates various assumptions including
volatility, expected life and interest rates to determine fair value. The
Company’s expected volatility assumption is based on the historical volatility
of Company’s stock. The expected life assumption is primarily based on the
simplified method of the terms of the options. The risk-free interest rate for
the expected term of the option is based on the U.S. Treasury yield curve
in effect at the time of grant.





The
Company is required to measure the cost of the equity instruments issued in
exchange for the receipt of goods or services from other than employees at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably
determinable. The value of equity instruments issued for consideration other
than employee services is determined on the earlier of a performance commitment
or completion of performance by the provider of goods or services.




- 40
-




Stock
compensation expense is recognized based on awards expected to
vest.  GAAP requires forfeitures to be estimated at the time of grant
and revised in subsequent periods, if necessary, when actual forfeitures differ
from those estimates.  There were no estimated forfeitures as the
Company has a short history of issuing options.





Derivative
Instrument





The
Company has used a cross currency interest rate swap, a derivative financial
instrument, to hedge the risk of rising interest rates on its variable
interest rate debt.  This type of derivative financial instrument is
known as a cash flow hedge.  Cash flow hedges are defined by GAAP
as derivative instruments designated as and used to hedge the exposure to
variability in expected future cash flows that is attributable to a particular
risk. For derivative instruments that are designated and qualify as a cash flow
hedge, the effective portion of the gain or loss on the derivative is
reported as a component of other comprehensive income, net of income taxes and
reclassified into earnings in the same period or periods during which the hedged
transaction affects earnings. Gains and losses on the derivatives representing
either hedge ineffectiveness or hedge components excluded from the assessment of
effectiveness are recognized in current earnings.




At the
inception of the transaction, the Company documents the relationship between
hedging instruments and hedged items, as well as its risk management objective
and the strategy for undertaking various hedge transactions. This process
includes linking all derivatives designated to specific firm commitments of
forecast transactions. The Company also documents its assessment, both at
inception and on an ongoing basis, of whether the derivative financial
instruments that are used in hedging transactions are highly effective in
offsetting changes in fair values or cash flows of hedged items. Any portion
deemed ineffective is recorded in earnings with the effective portion reflected
in accumulated other comprehensive income.





Fair
Value of Financial Instruments





On
January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009, the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:





-
                  Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active markets.-
                  Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.-
                  Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.





Recent
Accounting Pronouncement





In June
2009, the FASB issued authoritative guidance to eliminate the exception to
consolidate a qualifying special-purpose entity, change the approach to
determining the primary beneficiary of a variable interest entity and require
companies to more frequently re-assess whether they must consolidate variable
interest entities. Under the new guidance, the primary beneficiary of a variable
interest entity is identified qualitatively as the enterprise that has both (a)
the power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance, and (b) the obligation
to absorb losses of the entity that could potentially be significant to the
variable interest entity or the right to receive benefits from the entity that
could potentially be significant to the variable interest entity. This guidance
becomes effective for the Company at its fiscal 2011 year-end and interim
reporting periods thereafter. The Company does not expect this guidance to have
a material impact on its consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-01 – Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial
statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit
activity. The amendments also affect accounting and reporting by an entity that
exchanges a group of assets that constitutes a business or nonprofit
activity for an equity interest in another entity.  The amendments in
this update are effective beginning in the period that an entity adopts SFAS No.
160, “Non-controlling Interests in Consolidated Financial Statements – An
Amendment of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of
the date the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009.
The amendments in this update should be applied retrospectively to the first
period that an entity adopted SFAS No. 160. The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.




- 41
-




In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2.  A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value
measurements and describe the reasons for the transfers.  2) 
Activity in Level 3 fair value measurements.  In the reconciliation for
fair value measurements using significant unobservable inputs (Level 3), a
reporting entity should present separately information about purchases, sales,
issuances, and settlements (that is, on a gross basis rather than as one net
number). This update provides amendments to Subtopic 820-10 that clarifies
existing disclosures as follows: 1) Level of disaggregation. A reporting
entity should provide fair value measurement disclosures for each class of
assets and liabilities. A class is often a subset of assets or liabilities
within a line item in the statement of financial position. A reporting entity
needs to use judgment in determining the appropriate classes of assets and
liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques
and inputs used to measure fair value for both recurring and nonrecurring fair
value measurements. Those disclosures are required for fair value measurements
that fall in either Level 2 or Level 3. The new disclosures and
clarifications of existing disclosures are effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward of
activity in Level 3 fair value measurements. These disclosures are effective for
fiscal years beginning after December 15, 2010, and for interim periods within
those fiscal years. The Company is currently evaluating the impact of this ASU,
however, the Company does not expect the adoption of this ASU to have a material
impact on its consolidated financial statements.





In
February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and
Disclosure Requirements. This update addresses certain implementation issues
related to an entity’s requirement to perform and disclose subsequent-events
procedures, removes the requirement that public companies disclose the date of
their financial statements in both issued and revised financial statements.
According to the FASB, the revised statements include those that have been
changed to correct an error or conform to a retrospective application of U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial statements.




In March
2010, FASB issued ASU No. 2010-10 – Amendments for Certain Investment
Funds. This update defers the effective date of the amendments to the
consolidation requirements made by FASB Statement 167 to a reporting entity’s
interest in certain types of entities. The deferral will mainly impact the
evaluation of reporting enterprises’ interests in mutual funds, private equity
funds, hedge funds, real estate investment entities that measure their
investment at fair value, real estate investment trusts, and venture capital
funds. The ASU also clarifies guidance in Statement 167 that addresses whether
fee arrangements represent a variable interest for all service providers and
decision makers. The ASU is effective for interim and annual reporting periods
in fiscal year beginning after November 15, 2009. The adoption of this ASU did
not have a material impact on the Company’s consolidated financial
statements.




In March
2010, FASB issued ASU No. 2010-11 – Scope Exception Related to Embedded
Credit Derivatives. Embedded credit-derivative features related only to the
transfer of credit risk in the form of subordination of one financial instrument
to another are not subject to potential bifurcation and separate accounting as
clarified by recently issued FASB guidance. Other embedded credit-derivative
features are required to be analyzed to determine whether they must be accounted
for separately. This update provides guidance on whether embedded
credit-derivative features in financial instruments issued by structures such as
collateralized debt obligations (CDOs) and synthetic CDOs are subject to
bifurcation and separate accounting. The guidance is effective at the beginning
of a company’s first fiscal quarter beginning after June 15, 2010. The adoption
of this ASU did not  have a material impact on the Company’s
consolidated financial statements.





In
July 2010, the FASB issued Accounting Standards Update 2010-20 which amends
“Receivables” (Topic 310). ASU 2010-20 is intended to provide additional
information to assist financial statement users in assessing an entity’s risk
exposures and evaluating the adequacy of its allowance for credit losses. The
disclosures as of the end of a reporting period are effective for interim and
annual reporting periods ending on or after December 15, 2010. The disclosures
about activity that occurs during a reporting period are effective for interim
and annual reporting periods beginning on or after December 15, 2010. The
amendments in ASU 2010-20 encourage, but do not require, comparative disclosures
for earlier reporting periods that ended before initial adoption. However, an
entity should provide comparative disclosures for those reporting periods ending
after initial adoption. While ASU 2010-20 will not have a material impact on our
consolidated financial statements, we expect that it will expand our
disclosures related to notes receivables.





RESULTS
OF OPERATIONS





THREE
MONTHS ENDED SEPTEMBER 30, 2010 AND 2009




Revenues





For the
third quarter of 2010, total revenues were $109.35 million, up $62.42 million or
133%, compared with $46.93 million in the third quarter of 2009. The $62.42
million growth was mainly attributable to $2.91 million growth in linear motors,
$6.86 million growth in specialty micro motors, $51.75 million growth in
industrial rotary motors, and $0.9 million growth in other products. The
year-over-year sales growth was mainly due to the acquisition of Xi’an Tech Full
Simo in October 2009 and higher sales volume in all product lines driven by a
stronger economy in China in 2010 compared to 2009. Excluding the acquisition,
organic growth was 29% year over year.




- 42
-




By
product line, the $51.75 million or 250% higher revenues in industrial rotary
motors reflect a $48.93 million contribution from the acquisition of Xi’an Tech
Full Simo and $2.82 million or 14% higher revenues at Weihai Tech Full Simo.
Sales growth of $2.91 million or 18% in linear motors was primarily due to new
product sales from our linear motor propulsion systems developed for coal
transportation trains ($3.21 million in the third quarter of 2010 while none in
the third quarter of 2009). The $6.86 million or 81% sales increase in specialty
micro motors was driven by higher volumes in 2010 than in 2009.





International
sales totaled $5.66 million, or 5.2% of total sales, for the quarter, a 72%
increase compared with $3.30 million, or 7.0% of total sales, in the
third quarter of 2009, when the global economic downturn severely hurt our
international business. The international sales growth was driven primarily by
increased sales in our specialty micro motor and rotary motor
products.





The
following table presents the revenue contribution by percentage for each major
product line in the third quarter of 2010 in comparison with the third
quarter of 2009.





Percent of Total RevenuesProduct Line
                                    
                                    
                                    3Q10
                                    
                                    
                                    
                                    3Q09Linear
      Motors and Related Systems
                                    
                                    
                                    17.7
                                    %
                                    
                                    
                                    35.0
                                    %Specialty
      Micro-Motors
                                    
                                    
                                    14.0
                                    %
                                    
                                    
                                    18.0
                                    %Rotary
      Motors
                                    
                                    
                                    66.2
                                    %
                                    
                                    
                                    44.0
                                    %Weihai
                                    
                                    
                                    21.5
                                    %
                                    
                                    
                                    44.0
                                    %Xi’an
                                    
                                    
                                    44.7
                                    %
                                    
                                    
                                    N/AOthers
                                    
                                    
                                    2.1
                                    %
                                    
                                    
                                    3.0
                                    %Total
                                    
                                    
                                    100
                                    %
                                    
                                    
                                    100
                                    %International
      Sales
                                    
                                    
                                    5.2
                                    %
                                    
                                    
                                    7.0
                                    %




Net
Income





The
Company recorded a net income attributable to controlling interest of $17.87
million ($0.57 per diluted share) in the third quarter of 2010, compared
with a net loss of $1.91 million (a loss of $0.07 per diluted share) in the
same period of 2009. The net loss in the third quarter of 2009 included special
non-cash and non-recurring items totaling a net loss of $12.86 million or
$(0.47) per diluted share.





The
management of Harbin Electric uses non-GAAP adjusted net earnings to measure the
performance of the Company’s business internally by excluding non-recurring
items as well as special non-cash charges.  The Company’s management
believes that these non-GAAP adjusted financial measures allow management to
focus on managing business operating performance because these measures
reflect the essential operating activities of Harbin Electric and provide a
consistent method of comparison to historical periods. The Company believes that
providing the non-GAAP measures that management uses internally to its
investors is useful to investors for a number of reasons. The non-GAAP measures
provide a consistent basis for investors to understand Harbin Electric's
financial performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges. In addition, it allows
investors to evaluate the Company's performance using the same methodology and
information as that used by management. Non-GAAP measures are subject to
inherent limitations because they do not include all of the expenses included
under GAAP and because they involve the exercise of judgment of which charges
are excluded from the GAAP financial measure. However, the management of
Harbin Electric compensates for these limitations by providing the relevant
disclosure of the items excluded.





The
following table provides the non-GAAP financial measure and a reconciliation of
the non-GAAP measure to the GAAP net income.





Three Months Ended
      September 30,2010
                    
                    
                    2009Net
      Income Attributable to Controlling Interest (Loss)
                    
                    $
                    17,872,932
                    
                    
                    $
                    (1,907,964)Add
      Back (Deduct):Gain
      on debt repurchase
                    
                    $
                    0
                    
                    
                    $
                    (4,155,000)Amortization
      associated with debt repurchase
                    
                    $
                    0
                    
                    
                    $
                    7,279,487Loss
      on cross currency interest rate swap settlement
                    
                    $
                    0
                    
                    
                    $
                    9,000,000Provision
      for bad debts
                    
                    $
                    2,033,621
                    
                    
                    $
                    0Change
      in fair value of warrant
                    
                    $
                    301,918
                    
                    
                    $
                    736,546Adjusted
      Net Income Attributable to Controlling Interest
                    
                    $
                    20,208,471
                    
                    
                    $
                    10,953,069Diluted
      EPS Attributable to Controlling Interest
                    
                    $
                    0.57
                    
                    
                    $
                    (0.07)Add
      Back (Deduct):Gain
      on debt repurchase
                    
                    $
                    0
                    
                    
                    $
                    (0.15)Amortization
      associated with debt repurchase
                    
                    $
                    0
                    
                    
                    $
                    0.27Loss
      on cross currency interest rate swap settlement
                    
                    $
                    0
                    
                    
                    $
                    0.33Provision
      for bad debts
                    
                    $
                    0.07
                    
                    
                    $
                    0Change
      in fair value of warrant
                    
                    $
                    0.01
                    
                    
                    $
                    0.02Adjusted
      Diluted EPS Attributable to Controlling Interest
                    
                    $
                    0.65
                    
                    
                    $
                    0.40




- 43
-




During
the third quarter of 2009, the Company repurchased $26.5 million 2012 Notes at a
discount of 15% and the remaining $6 million 2010 Notes at a discount of 3%,
which resulted in a total gain of $4.16 million. As a result of the debt
repurchase, the Company recorded a $7.28 million additional amortization of debt
discount and debt issuance costs associated with the repurchased portion of the
debt. During the same quarter, the Company also terminated the cross currency
interest rate swap agreement that was intended as a cash flow hedge on the
scheduled payments of the $38 million 2012 Notes. As a result, $9 million was
transferred from the accumulated other comprehensive loss into earnings as a
loss from termination of the swap. There were no amounts recorded in the
consolidated statements of income in relation to ineffectiveness of this
interest swap prior to unwind.





For the
third quarter of 2010, excluding the $2.03 million non-cash provision for bad
debts ($0.07 per diluted share) and $0.30 million non-cash loss due to change in
fair value of warrants, the adjusted net income was $20.21 million ($0.65 per
diluted share), a 85% increase (63% increase per diluted share) from $10.95
million ($0.40 per diluted share) in the third quarter of 2009. The higher
adjusted net income in this quarter was primarily driven by higher sales across
all product lines and contributions from Xi’an Tech Full Simo. The adjusted net
profit margin was 18.48% in the current quarter compared with 23.3% in the third
quarter of 2009.




Gross
Profit Margin





The
following table presents the average gross profit margin by product line for the
third quarter of 2010, in comparison with the third quarter of
2009.





Gross Profit MarginProduct Line
                          
                          
                          3Q10
                          
                          
                          
                          3Q09Linear
      Motors and Related Systems
                          
                          
                          63.1
                          %
                          
                          
                          62.1
                          %Specialty
      Micro-Motors
                          
                          
                          31.5
                          %
                          
                          
                          40.4
                          %Rotary
      MotorsWeihai
                          
                          
                          10.9
                          %
                          
                          
                          11.8
                          %Xi’an
                          
                          
                          26.8
                          %
                          
                          
                          N/AOthers
                          
                          
                          39.2
                          %
                          
                          
                          51.8
                          %Corporate
      Average
                          
                          
                          30.7
                          %
                          
                          
                          35.7
                          %International
      Sales
                          
                          
                          28.1
                          %
                          
                          
                          44.2
                          %





The
overall gross margin declined to 30.7% in this quarter from 35.7% in the same
quarter of prior year. This change was primarily due to two factors: (1) Changes
in product mix where the percentage of lower margin rotary motors increased to
66% of total sales from 44% of total sales in the prior year due to acquisition
of Xian Tech Full Simo; and (2) Gross margin for the special micro-motors and
other products declined. By product line, the gross margin for linear motors
improved slightly attributable to new sales of higher margin products - linear
motor propulsion system for coal trains. The gross margin for specialty
micro-motors and other products declined primarily as a result of moving
the production from Harbin to the new plant in Shanghai, where manufacturing
costs such as labor and fixed costs are relatively higher, particularly at the
start-up stage. Higher raw material prices also hurt the margin.




Operating
Income and Expenses





Operating
income in the third quarter of 2010 totaled $21.85 million, compared with $13.04
million in the third quarter of 2009, representing a 68% year-over-year growth.
Higher operating income was mainly due to increased sales in all product lines,
including the contribution from the acquisition of Xi’an Tech Full
Simo.





Research
and development (“R&D”) expense totaled $1.66 million in the third quarter
of 2010, $1.19 million higher than the total of $0.47 million in the third
quarter of 2009. As technology and R&D is the Company’s long term strategic
focus, we have been making every effort to enhance our R&D projects and
invest in new product development in order to capture additional market
share and well position the Company for future growth. During the quarter, we
incurred more expenses associated with a few new key development
projects such as the automated control system for linear servo motors,
servo motor for high precision digital controlled machinery, a new model of
oil pumps, specialty explosion-proof rotary motors, and new models of specialty
micro-motors for new generation of automobiles. However, due to rapid sales
growth, our R&D expense remains below our budget of 2-3% of total
revenues.




- 44
-




Selling,
general and administrative (“SG&A”) expenses totaled $10.06 million or 9.2%
of total sales, compared with $3.25 million or 6.9% one year ago. The
acquisition of Xi’an Tech Full Simo and expansion of other facilities resulted
in higher depreciation expenses, and higher operating and administrative
expenses in this quarter compared to the same period last year. Particularly,
shipping and handling costs increased $0.99 million. The higher shipping
and handling costs were related to higher sales activities and to many changes
in the customer and product mix at Xi’an Tech Full Simo after the acquisition.
We have sold more high voltage motors – one of our best selling products at the
facility, and signed on more customers located farther away from Xi’an in other
provinces such as Shandong, Sichuan, Hubei provinces. In an effort to meet
customer requirements, improve customer satisfaction, and shorten the product
delivery time, starting in the third quarter of 2010 the Company has made a
major change by shifting some of its product deliveries from railroad shipping
to truck shipping. Although truck shipping is a more expensive method of
transportation, it is faster and can help the Company to respond to customer
demand at a faster rate, ensureing timely delivery of its products and
helping the Company gain market share. Additionally, the high voltage motors
usually require special handling and are mainly transported by truck shipping.
As more of our customers buying high voltage motors are located long distances
from the manufacturing site, it further increases shipping costs due to
distance.  Another major factor that contributed to higher SG&A
costs is associated with the production start-up at our new plant in Shanghai,
which had not yet begun start up in the third quarter of 2009.





During
the third quarter of 2010, management also increased the reserve
for accounts receivables by $2.0 million according to our accounts
receivable aging policy, which further drove our SG&A expense higher in this
quarter than the historical average level.





The
higher operating costs, in conjunction with lower gross margin, have caused the
decline in operating margin from 27.8% in the same quarter last year to 20.0% in
this quarter.





Other
Income, Net





Other
income, net, was $0.74 million in the current quarter, compared with $1.06
million in the third quarter of 2009. The other income mainly consists of income
from recycling scrap materials and selling production waste, a government
subsidy representing a 2.5% tax rate reduction granted to Harbin Tech Full to
encourage its high-technology related businesses, and sometimes government grant
or awards.




Interest
Expense





Net
interest expense was $1.13 million in the current quarter. This included
$0.29 million in amortization of debt discount and debt issuance costs in
connection with the Company’s 2012 Notes issued in 2006, $0.89 million interest
expense and $0.12 million in interest income. This compares to net interest
expense of $8.48 million in the third quarter of 2009, which included $8.21
million amortization of debt discount, of which $6.60 million was related to the
debt repurchase, and $0.90 million amortization of debt issuance costs, of which
$0.68 million was related to the debt repurchase. See Note 14 for a breakdown of
interest expense.




Income
Taxes





The
income tax provision was $3.30 million for the current quarter, compared with
$1.95 million for the third quarter of 2009. The year-over-year increase in
income tax was mainly attributable to the taxable income contributed by Xi’an
Tech Full Simo which was acquired in October 2009, higher income due to the
start-up of Shanghai Tech Full in the fourth quarter of 2009, and higher income
at our Harbin and Weihai facilities.




NINE
MONTHS ENDED SEPTEMBER 30, 2010 AND 2009




Revenues





For the
nine months ended September 30, 2010, total revenues were $320.28 million, up
$204.26 million or 176%, compared with $116.02 million for the nine months ended
September 30, 2009. The $204.26 million growth was attributable to $19.06
million growth in linear motors, $23.58 million growth in specialty micro
motors, $159.52 million growth in industrial rotary motors, and $2.10
million growth in other products. The year-over-year sales growth was mainly due
to the acquisition of Xi’an Tech Full Simo in October 2009 and higher sales
volume in all product lines driven by a stronger economy in China in 2010
compared to 2009. Excluding the acquisition, organic growth was 57% year over
year.





By
product line, the $159.52 million higher revenues in industrial rotary motors
reflect a $138.52 million contribution from the October 2009 acquisition of
Xi’an Tech Full Simo and $21.00 million or 43.3% higher revenues at Weihai Tech
Full Simo due to increased sales volume. Sales growth of $19.06 million or 47%
in linear motors was primarily due to higher sales volume of oil pumps (510
units in the nine months ended September 30, 2010, compared to 424 units in the
same period of 2009) and new product sales from our linear motor propulsion
systems developed for coal transportation trains ($14.03 million in the nine
months ended September 30, 2010, while none in the same period of 2009).
The $23.58 million or 102% sales increase in specialty micro motors was driven
by higher volumes in 2010 than in 2009.




- 45
-





International
sales totaled $18.3 million, or 5.7% of total sales, for the nine months ended
September 30, 2010, an increase of 81% compared with $10.14 million, or 8.7% of
total sales, in the nine months ended September 30, 2009, when the global
economic downturn severely hurt our international business. The international
sales growth was driven primarily by increased sales in our specialty micro
motor and rotary motor products.





The
following table presents the revenue contribution by percentage for each major
product line in the nine months ended September 30, 2010 in comparison with
the nine months ended September 30, 2009.





Percent of Total RevenuesNine Months Ended September 30,Product Line
                                          
                                          2010
                                          
                                          
                                          2009Linear
      Motors and Related Systems
                                          
                                          
                                          18.5
                                          %
                                          
                                          
                                          34.7
                                          %Specialty
      Micro-Motors
                                          
                                          
                                          14.6
                                          %
                                          
                                          
                                          19.9
                                          %Rotary
      Motors
                                          
                                          
                                          65.0
                                          %
                                          
                                          
                                          41.8
                                          %Weihai
                                          
                                          
                                          21.7
                                          %
                                          
                                          
                                          41.8
                                          %Xi’an
                                          
                                          
                                          43.3
                                          %
                                          
                                          
                                          N/AOthers
                                          
                                          
                                          1.9
                                          %
                                          
                                          
                                          3.6
                                          %Total
                                          
                                          
                                          100
                                          %
                                          
                                          
                                          100
                                          %International
      Sales
                                          
                                          
                                          5.7
                                          %
                                          
                                          
                                          8.7
                                          %





Net
Income





The
Company recorded a net income attributable to controlling interest of $64.10
million, or $2.05 per diluted share, in the nine months ended September 30,
2010, compared with $1.33 million, or $0.06 per diluted share, in the nine
months ended September 30, 2009, which included special non-cash and
non-recurring items totaling a net loss of $23.13 million or $(0.96) per diluted
share.




The
following table provides the non-GAAP financial measure and a reconciliation of
the non-GAAP measure to the GAAP net income.


Nine Months Ended
      September 30,2010
                  
                  
                  2009Net
      Income Attributable to Controlling Interest (Loss)
                  
                  $
                  64,101,424
                  
                  
                  $
                  1,327,006Add
      Back (Deduct):Other
      Income - Government Grant
                  
                  $
                  0
                  
                  
                  $
                  (1,172,560)Gain
      on debt repurchase
                  
                  $
                  0
                  
                  
                  $
                  (4,155,000)Amortization
      associated with debt repurchase
                  
                  $
                  0
                  
                  
                  $
                  7,279,487Loss
      on cross currency interest rate swap settlement
                  
                  $
                  0
                  
                  
                  $
                  9,000,000Loss
      from disposal of subdivision
                  
                  $
                  623,158
                  
                  
                  $
                  0Provision
      for bad debts
                  
                  $
                  1,889,235
                  
                  
                  $
                  0Change
      in fair value of warrant
                  
                  $
                  (1,121,461)
                  
                  
                  $
                  12,177,915Adjusted
      Net Income Attributable to Controlling Interest
                  
                  $
                  65,492,356
                  
                  
                  $
                  24,456,848Diluted
      EPS Attributable to Controlling Interest
                  
                  $
                  2.05
                  
                  
                  $
                  0.06Add
      Back (Deduct):Other
      Income - Government Grant
                  
                  $
                  0
                  
                  
                  $
                  (0.05)Gain
      on debt repurchase
                  
                  $
                  0
                  
                  
                  $
                  (0.17)Amortization
      associated with debt repurchase
                  
                  $
                  0
                  
                  
                  $
                  0.30Loss
      on cross currency interest rate swap settlement
                  
                  $
                  0
                  
                  
                  $
                  0.37
                  7Loss
      from disposal of subdivision
                  
                  $
                  0.02
                  
                  
                  $
                  0Provision
      for bad debts
                  
                  $
                  0.06
                  
                  
                  $
                  0Change
      in fair value of warrant
                  
                  $
                  (0.04)
                  
                  
                  $
                  0.51Adjusted
      Diluted EPS Attributable to Controlling Interest
                  
                  $
                  2.09
                  
                  
                  $
                  1.02





For the
nine months ended September 30, 2010, the adjusted net income was $65.49 million
($2.09 per diluted share) after excluding the $0.62 million loss from
disposal of subdivision, $1.89 million non-cash provision for bad debts, and the
$1.12 million non-cash gain due to change in fair value of warrants. This is a
168% of growth (105% increase per diluted share) from $24.46 million ($1.02 per
diluted share) in the same period of 2009, which excluded a gain of $1.17
million (RMB 8 million) government grant to support the Company’s subway train
project, a gain of $4.16 million on debt repurchase, a loss of $7.28 million
additional amortization of debt discount and debt issuance costs associated with
the repurchase of 2010 Notes and 2012 Notes, a loss of $9 million due to the
termination of the cross currency interest rate swap, and a loss of $12.18
million due to change in fair value of the warrants outstanding.




- 46
-




The
higher adjusted net income in the nine months ended September 30, 2010 was
primarily driven by higher sales across all product lines and contributions from
Xi’an Tech Full Simo. The adjusted net profit margin was 20.4% in the nine
months ended September 30, 2010 with 21.1% in the nine months
ended September 30, 2009.





Gross
Profit Margin





The
following table presents the average gross profit margin by product line for the
nine months ended September 30, 2010, in comparison with the nine months ended
September 30, 2009.





Gross Profit MarginProduct Line
                          
                          9
      Month 2010
                          
                          
                          9
      Month 2009Linear
      Motors and Related Systems
                          
                          
                          61.2
                          %
                          
                          
                          58.1
                          %Specialty
      Micro-Motors
                          
                          
                          35.5
                          %
                          
                          
                          40.3
                          %Rotary
      MotorsWeihai
                          
                          
                          11.8
                          %
                          
                          
                          11.9
                          %Xi’an
                          
                          
                          29.8
                          %
                          
                          
                          N/AOthers
                          
                          
                          37.6
                          %
                          
                          
                          50.0
                          %Corporate
      Average
                          
                          
                          32.7
                          %
                          
                          
                          35.0
                          %International
      Sales
                          
                          
                          35.2
                          %
                          
                          
                          43.8
                          %





The
overall gross margin declined to 32.7% in the nine months ended September 30,
2010 from 35.0% in the same period last year. This change was primarily due to
two factors: (1) Changes in product mix where the percentage of lower margin
rotary motors increased to 65% of total sales from 42% of total sales in the
prior year due to acquisition of Xian Tech Full Simo; and (2) Gross margin for
the special micro-motors and other products declined. By product line, the gross
margin for linear motors improved attributable to increased sales of higher
margin products such as oil pumps and linear motor propulsion system for coal
trains. The gross margin for specialty micro-motors and other products declined
primarily as a result of moving the production from Harbin to the new plant
in Shanghai, where manufacturing costs such as labor and fixed costs are
relatively higher, particularly at the start-up stage. Higher raw material
prices also hurt the margin. However, we were able to offset some of the impact
of higher raw material prices by increasing selling prices of our products
during a longer period of time, reflected by our relatively stable gross margin
at our Weihai facility





Operating
Income and Expenses





Operating
income of $77.67 million in the nine months ended September 30, 2010 increased
by 160% from $29.89 million in the nine months ended September 30,
2009. Higher operating income was mainly due to increased sales in all
product lines, including the contribution from the acquisition of Xi’an Tech
Full Simo.





Research
and development (“R&D”) expense totaled $2.62 million in the nine months
ended September 30, 2010, increased by $1.35 million from the total of $1.27
million in the nine months ended September 30, 2009. As technology and R&D
is the Company’s long term strategic focus, we have been making every effort to
enhance our R&D projects and invest in new product development in order
to capture additional market share and well position the Company for future
growth. During the third quarter this year, we incurred more expenses associated
with a few new key development projects such as the automated control
system for linear servo motors, servo motor for high precision digital
controlled machinery, a new model of oil pumps, specialty explosion-proof
rotary motors, and new models of specialty micro-motors for new generation of
automobiles. However, due to rapid sales growth, our R&D expense remains
below the level of last year and below our budget of 2-3% of total
revenues.





Selling,
general and administrative (“SG&A”) expenses totaled $24.36 million or 7.6%
of total sales for the nine months ended September 30, 2010, compared with $9.39
million or 8.1% for the same period in 2009. The acquisition of Xi’an Tech Full
Simo and expansion of other facilities resulted in higher depreciation expenses,
and higher operating and administrative expenses for the nine months ended
September 30, 2010 compared to the same period in 2009. Particularly, shipping
and handling costs increased $2.08 million. The higher shipping and
handling costs were related to higher sales activities and to many changes
in the customer and product mix at Xi’an Tech Full Simo after the
aquisition. We have sold more high voltage motors – one of our best selling
products at the facility, and signed on more customers located farther away from
Xi’an in other provinces such as Shandong, Sichuan, Hubei provinces. In an
effort to meet customer requirements, improve customer satisfaction, and shorten
the product delivery time, starting in the third quarter, the Company has made a
major change by shifting some of its product deliveries from railroad
shipping to truck shipping. Although truck shipping is a more expensive method
of transportation, it is faster and can help the Company to respond to customer
demand at a faster rate, ensuring timely delivery of its products and
helping the Company gain market share. Additionally, the high voltage motors
usually require special handling and are mainly transported by truck shipping.
As more of our customers buying high voltage motors are located long distances
from the manufacturing site, it further increases shipping costs due to
distance.  Another major factor that contributed to higher SG&A
costs is associated with the production start-up at our new plant in Shanghai,
which had not yet begun start up until the fourth quarter of
2009.




- 47
-




During
the nine months ended September 30, 2010, management also increased the reserve
for accounts receivables by $1.89 million according to our accounts
receivable aging policy, which also contributed to a higher SG&A
expense.





However,
as a percentage of total sales, the SG&A expenses this period is slightly
below that of the same period in last year, benefiting from the economies of
scale. Operating margin slightly declined to 24.3% in the current period from
25.8% in the same nine-month period one year ago, mainly due to lower gross
margin.





Other
Income, Net





Other
income, net, was $3.19 million in the nine months ended September 30, 2010,
compared with $3.70 million in the nine months ended September 30, 2009. The
other income mainly consists of income from recycling scrap materials and
selling production waste, a government subsidy representing a 2.5% tax rate
reduction granted to Harbin Tech Full to encourage its high-technology related
businesses, and sometimes government grant or awards.





Loss
from Disposal of Subdivision





During
the second quarter of 2010, Xi’an Tech Full Simo sold its equity interests in
three of its non-wholly-owned subsidiaries. As a result of the dispositions, a
net loss of $623,158 was recorded in loss from disposal of subdivisions,
net of income taxes, in the Company’s Consolidated Statements of
Operations.





Interest
Expense





Net
interest expense was $3.76 million for the nine months ended September 30,
2010. This included $1.80 million in amortization of debt discount and debt
issuance costs in connection with the Company’s 2012 Notes issued in 2006, $2.37
million interest expense and $0.54 million in interest income. This compares to
net interest expense of $10.76 million for the nine months ended September 30,
2009, which included a $10.22 million amortization of debt discount, of which
$6.60 million was related to the debt repurchase, and $1.18 million to
amortization of debt issuance costs, of which $0.68 million was related to the
debt repurchase. See Note 14 for a breakdown of interest expense.





Income
Taxes





The
income tax provision was $11.15 million for the nine months ended September 30,
2010, compared with $4.48 million for the same period of 2009. The
year-over-year increase in income tax was mainly attributable to the taxable
income contributed by Xi’an Tech Full Simo which was acquired in October 2009,
higher income due to the start-up of Shanghai Tech Full in the fourth quarter of
2009, and higher income at our Harbin and Weihai facilities.




LIQUIDITY
AND CAPITAL RESOURCES





A major
factor in the Company’s liquidity and capital resource planning is its
generation of operating cash flow, which is strongly dependent on the demand for
our products.  This is supplemented by our financing activities in the
capital markets including potentially debt and equity, which support major
acquisitions and capital investments for business growth.





As of
September 30, 2010, cash and cash equivalents were $55.53 million, compared to
$92.90 million as of December 31, 2009. Cash provided by operating activities
totaled $79.18 million for the nine months ended September 30, 2010, compared to
$37.45 million for the same period in 2009. Net cash used in investing
activities totaled approximately $111.73 million, compared to $9.45 million for
the nine months ended September 30, 2009.  Total cash used in financing
activities amounted to $5.87 million for the nine months ended September 30,
2010, compared with the total cash provided by financing activities of $78.48
million in the same period of 2009.





Cash
Provided by Operating Activities





Cash
provided by operating activities totaled $79.18 million for the nine months
ended September 30, 2010. The major components of cash provided by operating
activities are consolidated net income (net income attributable to both
controlling and non-controlling interest) adjusted for non-cash income and
expense items and changes in operating assets and liabilities.




Financing
Activities





For the
nine months ended September 30, 2010, cash used in financing activities totaled
$5.87 million, including $29.57 million repayment to short term loan and notes
payable – short term, $9.10 million principle repayment to the 2012 Notes,
and $32.21 million proceeds from short term loans and notes payable – short
term.





On August
29, 2006, the Company, Advanced Electric Motors, Inc. (“AEM”), Citadel Equity
Fund Ltd. (“Citadel”), and Merrill Lynch International (“Merrill Lynch”) and,
together with Citadel, the “Investors”) entered into a purchase agreement (the
“Purchase Agreement”) relating to the purchase and sale of (a) $50.0 million
aggregate principal amount of the Company’s Guaranteed Senior Secured Floating
Rate Notes (collectively, the “Notes”) and (b) fully detachable warrants (the
“Warrants”) to purchase an aggregate of 3,487,368 shares of our common stock.
The transaction closed on August 30, 2006. Interest on the Notes was
payable semi-annually in arrears, commencing March 1, 2007.




- 48
-




The Notes
were governed by an indenture, dated August 30, 2006, entered among the Company,
AEM, as guarantor, and The Bank of New York, as trustee for the Notes (the
“Indenture”). Of the $50.0 million aggregate principal amount of the Notes,
Citadel subscribed to $38.0 million of the principal amount of the
Notes, which were scheduled to mature on September 1, 2012 (the “2012
Notes”), and Merrill Lynch subscribed to $12.0 million of the principal amount
of the Notes, which were scheduled to mature on September 1, 2010 (the
“2010 Notes”). Pursuant to the Indenture, AEM has agreed, and all of our other
existing and future subsidiaries (other than subsidiaries domiciled in the
People’s Republic of China) are obligated, to guarantee, on a senior secured
basis, to the Investors and to the trustee the payment and performance of
our obligations.





The 2010
Notes bore interest, payable semi-annually in arrears, commencing March 1, 2007,
at a rate equal to LIBOR plus 4.75%. The 2010 Notes were subject to mandatory
redemption semi-annually commencing March 1, 2008 in the principal amount
$2,000,000 at a price equal to 100% of such principal amount.





In 2009,
the Company repurchased the unpaid portion of the 2010 Notes and repurchased
part of the 2012 Notes.





During
the nine months ended September 30, 2010, the Company repaid a total of $9.1
million principal amount of the 2012 Notes. As of September 30, 2010, the 2012
Notes were completely paid off.





The
Warrants are governed by a warrant agreement, dated August 30, 2006, between us
and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year
warrants to purchase an aggregate of 2,192,308 shares of our common stock, at an
exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii)
six-year warrants to purchase an aggregate of 525,830 shares of our common stock
at an exercise price of $10.84 per share (the “Second Tranche 2012
Warrants”) and, (iii) three-year warrants to purchase an aggregate of 769,230
shares of our common stock at an exercise price of $7.80 per share (the
“2009 Warrants”). The First Tranche 2012 Warrants and the Second Tranche 2012
Warrants were issued to Citadel, and the 2009 Warrants were issued to
Merrill Lynch. Each Warrant is exercisable at the option of the Warrant holder
at any time through the maturity date of such Warrant.





As of
September 30, 2010, a total of 366,697 Second Tranche 2012 Warrants remained
outstanding. In October 2010, a total of 183,349 warrants were exercised and the
Company received $1,987,503 in cash for the warrant exercise. After this
exercise, there are 183,348 warrants outstanding.





On July
28, 2010, the Company entered into a Loan Agreement, dated July 28, 2010 (the
“Loan Agreement”) with Abax Emerald Ltd., a Cayman Islands limited company
(“Abax”), pursuant to which Abax agreed to provide the Company with up to
$15,000,000 in loans (the “Loan”). The Loan shall be made pursuant to one or
more borrowings (each, an “Advance”) from time to time from the Closing Date
(July 28, 2010) to the date falling on the expiration of five (5) months after
the Closing Date upon delivering a notice from us to Abax. In lieu of payment of
interest in cash on each Advance, the outstanding principal amount thereof shall
accrete in value for the period commencing on the Borrowing Date (the date on
which any Advance is made from us to Abax) for such Advance and ending on the
day on which such Advance is repaid, at a rate equal to 10% per annum, computed
as described in the Agreement. We may voluntarily prepay any Advance (or portion
thereof in an integral multiple of $100,000) at its accreted value at any
time upon written notice to Abax. On the Maturity Date (six months after the
date of the Agreement), the Company is obligated to  repay the
remaining outstanding loan not theretofore paid, together with all fees and
other amounts payable under the Loan.





On July
29, 2010, the Company received the $15 million loan from Abax. This loan was
used to pay down debt and to support our capital expenditures and working
capital.





Investment
Activities





Net cash
used in investing activities totaled approximately $111.73 million for the nine
months ended September 30, 2010, including the remaining payment totaled
approximately $27.95 million for the acquisition of Xi’an Tech Full Simo, a
payment of $27.68 million for acquiring remaining interests of non-wholly owned
subsidiaries under Xi’an Tech Full Simo, and capital expenditures totaled $57.57
million.




On
October 2, 2009, Harbin Tech Full, a wholly-owned subsidiary of the Company,
entered  into an Equity Acquisition Agreement (the “Agreement”) with
Xi’an Simo Electric Co. Ltd. (“Xi’an Simo”) and Shaanxi Electric Machinery
Association (“Shaanxi Electric” and collectively with Xi’an Simo, the “Selling
Shareholders”) whereby Harbin Tech Full agreed to acquire (i) 100% of the
outstanding shares of Xi’an Simo Motor Incorporation (Group) (“Simo
Motor”), which was 99.94% owned by Xi’an Simo and 0.06% owned by Shaanxi
Electric, and (ii) all corresponding assets of Simo Motor, including but not
limited to, all of the manufacturing equipment, real-estate, land use rights,
stocks, raw materials, automobiles, intellectual property, receivables, other
receivables, payables, business contracts, and external investments owned by
Simo Motor for a purchase price of equal to no less than six (6) times and no
more than eight (8) times the 2008 audited net profits of Simo Motor.
Pursuant to the Agreement, Harbin Tech Full was required to make a payment to
the Selling Shareholders equivalent to six (6) times the 2008 audited net profit
of Simo Motor within ten (10) business days after the effectiveness of the
Agreement. The Agreement also provided that upon verification of the assets and
capital of Simo Motor within seven months of the closing date of the
acquisition, Harbin Tech Full may be required to make an additional payment to
the Selling Shareholders in an amount not to exceed two (2) times the 2008
audited net profit of Simo Motor.




- 49
-




On
October 13, 2009, the Company completed the acquisition of Simo Motor. On
October 22, 2009, the Company paid approximately $84.0 million (RMB
572.7 million) to the Selling Share holders. As of the closing date, Harbin
Tech Full had completed the registration of the share transfer with the
requisite PRC authorities and had obtained the required business registration
and transfer of licenses of Simo Motor, all as contemplated by the Agreement. On
October 13, 2009, Simo Motor changed its name to Xi’an Tech Full Simo Motor Co.
Ltd.





During
the first quarter of 2010, the Company made an additional cash payment in an
amount of $27.95 million (RMB 190.5 million) to the Selling Shareholders
representing the unpaid portion for the acquisition of Xi’an Tech Full Simo. The
acquisition of Xi’an Tech Full Simo has been fully paid for after this
payment pursuant to the Agreement.





On June
3, 2010, Xi’an Tech Full Simo entered into four Share Purchase Agreements, each
dated as of June 3, 2010 with certain shareholders of four subsidiaries of
Xi’an Tech Full Simo pursuant to which Xi’an Tech Full Simo agreed to acquire
all of the equity interests of these subsidiaries that were not held by Xi’an
Tech Full Simo. Pursuant to these Share Purchase Agreements, effective April 1,
2010, Xi’an Tech Full Simo would own 100% of the outstanding equity of the four
subsidiaries. These transactions were closed in the months of June and July
2010. The aggregate purchase price paid by Xi’an Tech Full Simo for these equity
interests is $27.60 million (RMB188.2 million), of which $26.50 million was paid
in May and June 2010 with remaining $1.1 million paid in July 2010.





In
addition, on June 3, 2010, Xi’an Tech Full Simo entered into three Share
Purchase Agreements, each dated as of June 3, 2010 with certain shareholders of
three subsidiaries of Xi’an Tech Full Simo pursuant to which Xi’an Tech Full
Simo agreed to sell its equity interests in such subsidiaries to these
shareholders. Pursuant to these three Share Purchase Agreements, effective
April 1, 2010, Xi’an Tech Full would no longer own any of the outstanding equity
of the three subsidiaries. These transactions were closed in the months of June
and July 2010. The aggregate sales price received by Xi’an Tech Full Simo for
these equity interests is $1.84 million (RMB12.55 million). We received $0.72
million in June 2010 and the remaining $1.12 million received in July
2010.





Contractual
Obligations





On
September 8, 2006, HTFE entered into an agreement (“Land Use Agreement”) with
Shanghai Lingang Investment and Development Company Limited (“Shanghai Lingang”)
with respect to HTFE’s lease and use of 40,800 square meters of State-owned land
in the Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The term of the
land use agreement is 50 years. In June 2009, the Land Use Agreement was
revised with the land size increased to a total of approximately 53,000
square meters. The aggregate amount HTFE shall pay to Shanghai Lingang is now
approximately $6.28 million (RMB42.84 million) ("Fee"), approximately 97% or
$6.08 million (RMB 41.45 million) has been paid as of June 30, 2010 with the
balance payable in installments.




In
October 2008, the Company, through its then wholly-owned subsidiary Advanced
Automation Group, LLC (“AAG”), formed Advanced Automation Group Shanghai, Ltd.
(“AAG Shanghai”), a wholly-owned subsidiary in China, to design, develop,
manufacture, sell and service custom industrial automation controllers for
linear motors. The registered capital is $1 million. AAG has invested $800,000
in AAG Shanghai through September 30, 2010.





The
Company entered into an agreement (“Original Agreement”) with Shelton
Technology, LLC on April 9, 2007 whereby the Company and Shelton agreed to work
together through the Company’s wholly-owned subsidiary, Advanced Automation
Group, LLC (“AAG”), to design, develop, and manufacture custom industrial
automation controllers.  Pursuant to the Original Agreement, the
Company is required to invest a total of $3 million in AAG while Shelton
contributes an exclusive worldwide royalty-free license for motorized automation
technology. Shelton is entitled to receive 49% of any profits earned by AAG
through the initial term of the Agreement which ended August 31, 2008. The
Company and Shelton entered into a first amendment to the Original Agreement on
December 11, 2008 to extend the term of the Original Agreement from August 31,
2008 to December 31, 2008. On April 21, 2009, the Company and Shelton entered
into a second amendment to the Original Agreement to further extend the term to
June 30, 2009. On December 7, 2009, the Company and Shelton entered into
the third amendment to the Original Agreement to further extend the term to
December 31, 2009.





On August
25, 2010, Advance Automation Group, LLC, a Delaware limited liability company
(“AAG”) and an indirect wholly owned subsidiary of Harbin Electric, Inc. (the
“Company”), the Company, Shelton Technology, LLC, a Michigan limited liability
company (“Shelton”) and Ms. Julie Chen, entered into an Option Exercise
Agreement (“Option Agreement”) dated as of August 25, 2010 and effective as of
July 1, 2010, pursuant to which the Company exercised the right, previously
granted to the Company under a letter agreement dated April 9, 2007 between the
Company and Shelton, as amended on December 11, 2008, April 21, 2009 and
December 7, 2009, to require Shelton to contribute all right, title and interest
in and to its proprietary technologies, product designs, electric assembly
manufacturing techniques and U.S. customer accounts (“Intellectual Properties”)
to AAG in consideration for a limited liability company interest in AAG
entitling Shelton to a 49% share of AAG’s profits, losses, and distributions of
its assets, in accordance with AAG’s limited liability company
agreement.




- 50
-




In
connection with the Option Agreement, on August 25, 2010, Advanced Electric
Motors, Inc., a Delaware corporation (“AEM”) and a wholly owned subsidiary of
the Company, entered into an Amended and Restated Limited Liability Company
Agreement (“LLC Agreement”) dated as of August 25, 2010 and effective as of July
1, 2010, with Shelton whereby (i) Shelton agreed to contribute all right, title
and interest in and to its Intellectual Properties to AAG in consideration for a
membership interest in AAG entitling Shelton to receive 49% of any profits
earned by AAG through the terms of the LLC Agreement; and (ii) AEM agreed to
contribute all of AAG’s assets (subject to all of the liabilities of AAG) with
fair market value of $3 million in consideration for a membership interest in
AAG entitling AEM to receive 51% of any profits earned by AAG through the terms
of the LLC Agreement. The Intellectual Properties have been valued at
$2,882,353 and the Company, through AEM, has previously contributed a total of
$2 million to AAG with the remaining $1 million to be paid by AEM to AAG prior
to December 31, 2011.





The
Company enters into non-cancelable purchase commitments with its vendors. As of
September 30, 2010, and December 31, 2009, the Company was obligated under the
non-cancelable commitments to purchase materials totaling $584,064 and
$456,174, respectively. These commitments are short-term and expire within one
year. The Company has experienced no losses on these purchase commitments over
the years.





Off-Balance
Sheet Arrangements





None.





Item
3. Quantitative and Qualitative Disclosures about Market Risk




Information
relating to quantitative and qualitative disclosures about market risk is
provided in the Company’s 2009 Annual Report on Form 10-K, which information is
incorporated herein by reference. There have been no material changes in the
Company’s
exposure to market risk since December 31, 2009.




Item
4. Controls and Procedures




(a)
Evaluation of Disclosure Controls and Procedures





We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed pursuant to the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules, regulations and related forms, and
that such information is accumulated and communicated to our principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure.





Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, the Company
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures as of September 30, 2010, as such term is
defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on this evaluation,
our principal executive officer and principal financial officer have concluded
that during the period covered by this report, the Company’s disclosure controls
and procedures are effective as of such date at a reasonable assurance level to
ensure that information required to be disclosed by us in our Exchange Act
reports is recorded, processed, summarized, and reported within the time periods
specified in the SEC’s rules and forms, and that such information is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.





(b) Changes
in Internal Control over Financial Reporting





There
have been no changes in out internal control over financial reporting that
occurred during the third quarter of 2010 covered by this Quarterly Report that
have materially affected, or are reasonably likely to materially affect, the
Company’s
internal control over finacial reporting.








PART II. OTHER
INFORMATION




Item 1. Legal
Proceedings





Ten
punitive shareholder class action complaints have been filed against Harbin
and/or certain officers and directors thereof in connection with the October 10,
2010 non-binding proposal made by Mr. Tianfu Yang and Baring for Mr. Yang and
the Baring Fund to acquire all of the outstanding shares of Common Stock of
Harbin not currently owned by Mr. Yang and his affiliates for $24.00 per share
in cash, subject to certain conditions (the “Yang Proposal”). In each complaint,
the plaintiffs challenge the Yang Proposal and allege, among other things, that
the consideration to be paid in such proposal is unfair and inadequate. The
complaints seek, among other relief, to enjoin defendants from consummating the
Yang Proposal and to direct defendants to exercise their fiduciary duties to
obtain a transaction that is in the best interests of the Company’s
shareholders. Seven of these complaints were filed in the State of Nevada, and
the remaining complaints were filed in the State of New York. We have reviewed
the allegations contained in the various complaints and believe they are without
merit. We intend to defend the litigation vigorously. As such, based on the
information known to us to date, we do not believe that it is probable that a
material judgment against us will result. In accordance with ASC Topic 450, no
liability has been accrued.




- 51
-




Item
1A. Risk Factors





An
investment in our common stock is very risky. You should carefully consider the
risk factors described below before making an investment decision. If any of the
following risks actually occurs, our business, financial condition or operating
results could be materially and adversely affected. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment. Additional risks and uncertainties not currently foreseeable to us
may also impair our business operations.




GENERAL
RISKS RELATING TO OUR BUSINESS





Our
rapid growth may strain our resources.




Our
revenues in the third quarter of 2010 increased by 133% from the third quarter
of 2009 and 85% in the year ended December 31, 2009 versus the year ended
December 31, 2008. However, it is unlikely that we will maintain such
growth in the long term and we cannot assure any growth of our business for any
period. Our rapid expansion will place significant strain on our management and
our operational, accounting, and information systems as well as our financial
resources. We expect that we will need to continue to improve our financial
controls, operating procedures, and management information systems. We will also
need to effectively hire, train, motivate, and manage our employees. In
addition, we may require additional financial resources to fund our growing
working capital needs. Our failure to manage our growth could disrupt our
operations and ultimately prevent us from generating the profits we
expect.




Our
debt may constrict our future operations and cash flows.





As of
September 30, 2010, our PRC subsidiaries had a total of approximately $52.88
million loans outstanding. These loans were obtained from local PRC banks and
unrelated individual companies. They are used to support our working capital. On
July 29, 2010, we borrowed $15 million pursuant to the Loan Agreement we entered
into on July 28, 2010 with Abax.  This loan was used to pay down debt
and to support our capital expenditures and working capital. These obligations
could have important consequences to you. For example, they could:





●
            reduce
      the availability of our cash flow to fund future working capital, capital
      expenditures, acquisitions and other general corporate
      purposes;





●
            limit
      our ability to obtain additional financing for working capital, capital
      expenditures, and other general corporate
  requirements;





●
            in
      the case of the Notes, expose us to interest rate fluctuations because the
      interest rate for the Notes is variable;
and





●
            place
      us at a competitive disadvantage compared to competitors that may have
      proportionately less debt.





In
addition, our ability to make scheduled payments or refinance our obligations
depends on our successful financial and operating performance, cash flows, and
capital resources, which in turn depend upon prevailing economic conditions and
certain financial, business, and other factors, many of which are beyond our
control. If our cash flows and capital resources are insufficient to fund our
debt obligations, we may be forced to reduce or delay capital expenditures, sell
material assets or operations, obtain additional capital, restructure our debt,
or declare bankruptcy.





Covenants
in the Loan Agreement with Abax restrict our ability to engage in or enter
into a variety of transactions.





Our Loan
Agreement with Abax contains certain covenants that may limit our discretion in
operating our business. In particular, we are limited in our ability to merge,
consolidate, alter our corporate structure, transfer substantially all of our
assets, incur liens, and engage in transactions with affiliates. The Loan
Agreement also requires us to maintain certain financial ratios. These
covenants and ratios could have an adverse effect on our business by limiting
our ability to take advantage of financing, merger and acquisition, or other
corporate opportunities and to fund our operations.





Our
success depends on our management team and other key personnel, the loss of any
of whom could disrupt our business operations.




Our
future success will depend in substantial part on the continued service of the
members of our senior management. The loss of the services of one or more of our
key personnel could impede implementation of our business plan and result in
reduced profitability. We do not carry key person life insurance on any of our
officers or employees. Our future success will also depend on the continued
ability to attract, retain, and motivate highly qualified technical sales and
marketing customer support.




Because
of the rapid growth of the economy in China, competition for qualified personnel
is intense. We cannot assure you that we will be able to retain our key
personnel or that we will be able to attract, assimilate, or retain qualified
personnel in the future.




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We
depend on a few key customers, the loss of any of which could cause a
significant decline in our revenues.





Revenue
from one customer (China National Petroleum Corporation) accounted for more than
10% of the net revenue for the three months ended September 30, 2010. No
customer accounted for more than 10% of the net revenue for the nine months
ended September 30, 2010. The loss of this major customer would adversely affect
our revenues and profitability.





We
depend on the supply of raw materials and key component parts, and any adverse
changes in such supply or the costs of raw materials may adversely affect our
operations.




No vendor
accounted for more than 10% of the raw material purchases for the three months
ended September 30, 2010. Three major vendors provided approximately 44% of the
Company’s purchases of raw materials for the three months ended September 30,
2009. No vendor accounted for more than 10% of the raw material purchases
for the nine months ended September 30, 2010. Four major vendors provided
approximately 74% of the Company’s purchases of raw materials for the nine
months ended September 30, 2009, with each vendor individually accounting for
40%, 13%, 11%, and 10%, respectively. Any material change in the spot and
forward rates could have a material adverse effect on the cost of our raw
materials and on our operations. In addition, if we need alternative sources for
key component parts for any reason, these component parts may not be immediately
available to us. If alternative suppliers are not immediately available, we will
have to identify and qualify alternative suppliers, and production of these
components may be delayed. We may not be able to find an adequate alternative
supplier in a reasonable time period or on commercially acceptable terms, if at
all. Shipments of affected products have been limited or delayed as a result of
such problems in the past, and similar problems could occur in the future. An
inability to obtain our key source supplies for the manufacture of our products
might require us to delay shipments of products, harm customer relationships or
force us to curtail or cease operations.





We
may experience material disruptions to our manufacturing operation.





While we
seek to operate our facilities in compliance with applicable rules and
regulations and take measures to minimize the risks of disruption at our
facilities, a material disruption at one of our manufacturing facilities could
prevent us from meeting customer demand, reduce our sales and/or
negatively impact our financial results. Any of our manufacturing
facilities, or any of our machines within an otherwise operational facility,
could cease operations unexpectedly due to a number of events,
including:





●
            unscheduled
      maintenance outages;





●
            prolonged
      power failures;





●
            an
      equipment failure;





●
            disruptions
      in the transportation infrastructure including roads, bridges, railroad
      tracks;





●
            fires,
      floods, earthquakes, or other catastrophes;
and





●
            other
      operational problems.





We
may not be able to adequately protect and maintain our intellectual property,
which could weaken our competitive position.





Our
success will depend on our ability to continue to develop and market electric
motor products. We have been granted 20 patents in China relating to linear
motor and automobile specialty micro-motor applications. No assurance can be
given that such patents will not be challenged, invalidated, infringed or
circumvented, or that such intellectual property rights will provide a
competitive advantage to us. The implementation and enforcement of PRC
intellectual property laws historically have not been vigorous or consistent,
primarily because of ambiguities in the PRC laws and a relative lack of
developed enforcement mechanisms. Accordingly, intellectual property rights
and confidentiality protections in the PRC are not as effective as in the United
States and other countries. Policing the unauthorized use of proprietary
technology is difficult and expensive, and we might need to resort to litigation
to enforce or defend patents issued to us or to determine the enforceability,
scope and validity of our proprietary rights or those of others. Such litigation
will require significant expenditures of cash and management efforts and could
harm our business, financial condition and results of operations. An adverse
determination in any such litigation will impair our intellectual property
rights and may harm our business, competitive position, business prospects and
reputation. In addition, since we have chosen to secure patents only in China,
we may not be in a position to protect our inventions and technology in other
countries in which we sell our product, which could result in increased
competition and lower pricing for our products.





RISKS
RELATING TO DOING BUSINESS IN THE PEOPLE’S REPUBLIC OF CHINA





China’s
economic policies could adversely affect our business.





Substantially
all of our assets are located in China and substantially all of our revenues are
derived from our operations in China. Accordingly, our results of operations and
prospects are subject, to a significant extent, to economic, political and
legal developments in China.




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While
China’s economy has experienced significant growth in the past 30 years, it has
been uneven, both geographically and among various sectors of the economy. The
Chinese government has implemented various measures to encourage economic growth
and guide the allocation of resources. Some of these measures benefit the
overall economy of China, but may also have a negative effect on us. For
example, our operating results and financial condition may be adversely
affected by government control over capital investments or changes in
tax regulations.





The
economy of China has been changing from a planned economy to a more
market-oriented economy. In recent years, the Chinese government has implemented
measures emphasizing market forces for economic reform, reduction of state
ownership of productive assets, and establishment of corporate governance in
business enterprises; however, a substantial portion of productive assets in
China are still owned by the Chinese government. In addition, the Chinese
government continues to play a significant role in regulating industry
development by imposing industrial policies. It also exercises significant
control over China’s economic growth through the allocation of resources,
controlling payment of foreign currency-denominated obligations, setting
monetary policy, and providing preferential treatment to particular industries
or companies.





PRC
laws and regulations governing our current business operations are sometimes
vague and uncertain and any changes in such laws and regulations may harm our
business.





There are
substantial uncertainties regarding the interpretation and application of PRC
laws and regulations including, but not limited to, the laws and regulations
governing our business, and the enforcement and performance of our arrangements
with customers in the event of the imposition of statutory liens, death,
bankruptcy and criminal proceedings. We are considered foreign persons or
foreign funded enterprises under PRC laws and, as a result, we are required
to comply with PRC laws and regulations. These laws and regulations are
sometimes vague and may be subject to future changes, and their official
interpretation and enforcement may involve substantial uncertainty. The
effectiveness of newly enacted laws, regulations or amendments may be delayed,
resulting in detrimental reliance. New laws and regulations that affect existing
and proposed future businesses may also be applied retroactively. We cannot
predict what effect the interpretation of existing or new PRC laws or
regulations may have on our business.





Inflation
in the PRC could negatively affect our profitability and growth.





The PRC
economy has experienced rapid growth. Rapid economic growth could lead to growth
in the money supply and rising inflation. If prices for our products rise at a
rate that is insufficient to compensate for the rise in the cost of supplies, it
may harm our profitability. In order to control inflation in the past, the PRC
government has imposed controls on bank credit, limits on loans for fixed
assets and restrictions on state bank lending. Such policies can lead to a
slowing of economic growth. Recently, the People’s Bank of China, the PRC’s
central bank, raised interest rates and indicated in a statement that the
measure was prompted by inflationary concerns in the Chinese economy. Repeated
rises in interest rates by the central bank would likely slow economic activity
in China which could, in turn, materially increase our costs and also
reduce demand for our products.





PRC
regulations relating to mergers, offshore companies, and Chinese stockholders,
if applied to us, may limit our ability to operate our business as we see
fit.





Regulations
govern the process by which we may participate in an acquisition of assets or
equity interests. Depending on the structure of the transaction, the new
regulation will require Chinese parties to make a series of applications and
supplemental applications to various government agencies. In some instances, the
application process may require the presentation of economic data concerning a
transaction, including appraisals of the target business and evaluations of the
acquirer, which are designed to allow the government to assess the
transaction. Government approvals will have expiration dates by which a
transaction must be completed and reported to the government agencies.
Compliance with the new regulations is likely to be more time consuming and
expensive than in the past and the government can now exert more control
over the combination of two businesses. Accordingly, due to the PRC
regulations, our ability to engage in business combination transactions in China
through our Chinese subsidiaries has become significantly more complicated, time
consuming and expensive, and we may not be able to negotiate transactions that
are acceptable to us or sufficiently protective of our interests in a
transaction.





If
preferential tax concessions granted by the PRC government change or expire, our
financial results could be materially and adversely affected.





Our
financial results may be adversely affected by changes to or expiration of
preferential tax concessions that our Chinese subsidiaries currently enjoy. The
statutory tax rate generally applicable to domestic Chinese companies was 33%
before January 1, 2008. On January 1, 2008, the new Chinese Enterprise Income
Tax (“EIT”) law replaced the existing laws for Domestic Enterprises (“DES”),
such as Weihai Tech Full Simo Motor Co. Ltd. and Xi’an Tech Full Simo Motor Co.,
Ltd., and Foreign Invested Enterprises (“FIEs”), such as Harbin Tech Full
Electric Co., Ltd., Shanghai Tech Full Electric Co., Ltd., and Advanced
Automation Group Shanghai, Ltd. The new standard EIT rate of 25% is now
applicable to both DES and FIEs. The PRC government provides reduced tax
rates for productive foreign investment enterprises in the Economic and
Technological Development Zones and for enterprises engaged in production or
business operations in the Special Economic Zones.  These preferential
tax rates are generally graduated, starting at 0% and increasing to the standard
EIT rate of 25% over time.  Our operations under Harbin Tech Full
Electric Co., Ltd. were subject to a 10% preferential tax rate until December
31, 2010. Our operations under Shanghai Tech Full Electric Co., Ltd. were
subject to 0% preferential tax rate in 2009 and is subject to 11% in 2010. Our
operations under Xi’an Tech Full Simo Motor Co., Ltd. were subject to a 15%
preferential tax rate. As a result, the estimated tax savings for the nine
months ended September 30, 2010, and 2009 amounted to $9,383,605 and $4,973,700,
respectively. The estimated tax savings for the three months ended September 30,
2010, and 2009 amounted to $2,885,903 and $2,111,267,
respectively.  Tax laws in China are subject to interpretations by
relevant tax authorities. Preferential tax rates may not remain in effect or may
change, in which case we may be required to pay the higher income tax rate
generally applicable to Chinese companies, or such other rate as is required by
the laws of China.




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Fluctuation
in the value of the RMB may have a material adverse effect on your
investment.





The value
of RMB against the U.S. dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Our revenues and costs are mostly denominated in RMB. Any significant
fluctuation in value of RMB may materially and adversely affect our cash flows,
revenues, earnings, and financial position, and the value of our stock in U.S.
dollars. For example, an appreciation of RMB against the U.S. dollar would
make any new RMB denominated investments or expenditures more costly to us, to
the extent that we need to convert U.S. dollars into RMB for such purposes. In
addition, the depreciation of significant U.S. dollar denominated assets could
result in a charge to our income statement and a reduction in the value of these
assets.





We
must comply with the Foreign Corrupt Practices Act.





We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits U.S. companies from engaging in bribery or other prohibited payments
to foreign officials for the purpose of obtaining or retaining business. Foreign
companies, including some of our competitors, are not subject to these
prohibitions. Corruption, extortion, bribery, pay-offs, theft, and other
fraudulent practices occur from time-to-time in mainland China. If our
competitors engage in these practices, they may receive preferential treatment
from personnel of some companies, giving our competitors an advantage in
securing business or from government officials who might give them priority in
obtaining new licenses, which would put us at a disadvantage. Although the
Company educates our employees not to engage in these illegal practices, we
cannot assure you that our employees or other agents will not engage in such
conduct for which we might be held responsible. If our employees or other agents
are found to have engaged in such practices, we could suffer severe
penalties.





The
Chinese government exerts substantial influence over the manner in which we must
conduct our business activities.





Our
ability to operate in China may be harmed by changes in its laws and
regulations, including those related to taxation, environmental regulations,
land use rights, property and other matters. We believe that our operations in
China are in material compliance with all applicable legal and regulatory
requirements. However, the central or local governments of these jurisdictions
may impose new, stricter regulations or interpretations of existing regulations
that would require additional expenditures and efforts on our part to ensure our
compliance with such regulations and interpretations. Government actions in
the future, including any decision not to continue to support recent economic
reforms and to return to a more centrally planned economy or regional or local
variations in the implementation of economic policies, could have a significant
effect on economic conditions in China or particular regions thereof, and could
require us to divest ourselves of any interest we then hold in Chinese
properties.





We
are subject to environmental laws and regulations in the PRC.





We are
subject to environmental laws and regulations in the PRC. Any failure by us to
comply fully with such laws and regulations will result in us being subject to
penalties and fines or being required to pay damages. Although we believe we are
currently in compliance with the environmental regulations in all material
respects, any change in the regulations may require us to acquire equipment or
incur additional capital expenditure or costs in order to comply with such
regulations. Our profits will be adversely affected if we are unable to pass on
such additional costs to our customers.





We
may have difficulty establishing adequate management, legal, and financial
controls in the PRC.





The PRC
historically has been deficient in Western style management and financial
reporting concepts and practices, as well as in modern banking, computer, and
other control systems. We may have difficulty in hiring and retaining a
sufficient number of qualified employees to work in the PRC. As a result of
these factors, we may experience difficulty in establishing management, legal
and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records, and instituting business
practices that meet Western standards.





It
will be extremely difficult to acquire jurisdiction over and enforce liabilities
against our officers, directors, and assets based in the PRC.





Because
most of our executive officers and several of our directors, including our
chairman of the Board of Directors, are Chinese citizens, it may be difficult,
if not impossible, to acquire jurisdiction over these persons in the event a
lawsuit is initiated against us and/or our officers and directors by a
stockholder or group of stockholders in the United States. Also, because the
majority of our assets are located in the PRC, it would also be extremely
difficult to access those assets to satisfy an award entered against us in a
U.S. court.




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The
legal system in China has inherent uncertainties that may limit the legal
protections available in the event of any claims or disputes with third
parties.





The legal
system in China is based on written statutes. Prior court decisions may be cited
for reference but have limited precedential value. Since 1979, the central
government has promulgated laws and regulations dealing with economic matters
such as foreign investment, corporate organization and governance, commerce,
taxation and trade. As China’s foreign investment laws and regulations are
relatively new and the legal system is still evolving, the interpretation of
many laws, regulations and rules is not always uniform and enforcement of
these laws, regulations and rules involve uncertainties, which may limit the
remedies available in the event of any claims or disputes with third parties. In
addition, any litigation in China may be protracted and result in substantial
costs and diversion of resources and management attention.





RISKS
ASSOCIATED WITH OUR COMMON STOCK





There
can be no assurance that any definitive offer will be made with respect to the
proposal made by Mr. Yang and Baring to acquire all of our outstanding common
stock not held by Mr. Yang and his affiliates, that any agreement will be
executed or that this or any other transaction will be approved or consummated.
The absence of a proposal to acquire our common stock would likely have an
effect on the market price of our common stock.





On
October 10, 2010, our Board of Directors, or the Board, received the proposal
from Mr. Tianfu Yang and Baring described in Part I, Item 2. “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” of
this Quarterly Report on Form 10-Q. The public announcement of the proposal
affected the Company’s stock price. There can be no assurance that any
definitive offer will be made with respect to the proposal made by Mr. Yang and
Baring, that any agreement will be executed or that this or any other
transaction will be approved or consummated. The absence of a proposal to
acquire our Common Stock, or changes in the proposal, as well as the
commencement and conduct of the litigation regarding the proposal described in
Part II, Item 1, “Legal Proceedings” would likely have an effect on the market
price of our Common Stock.





Our
common stock may be affected by limited trading volume and may fluctuate
significantly.




Our
common stock is traded on the Nasdaq Global Select Market. Although an active
trading market has developed for our common stock, there can be no assurance
that an active trading market for our common stock will be sustained. Failure to
maintain an active trading market for our common stock may adversely affect our
stockholders’ ability to sell our common stock in short time periods, or
at all. In addition, sales of substantial amounts of our common stock in
the public market could harm the market price of our common stock.
Our common stock has experienced, and may experience in the future,
significant price and volume fluctuations, which could adversely affect the
market price of our common stock.





We
do not anticipate paying cash dividends on our common stock in the foreseeable
future.




We do not
anticipate paying cash dividends in the foreseeable future. Presently, we intend
to retain all of our earnings, if any, to finance development and expansion of
our business. The Indenture pursuant to which the Notes were issued prohibits us
from paying any dividends on our capital stock while the Notes remain
outstanding. PRC capital and currency regulations may also limit our ability to
pay dividends. Consequently, the only opportunity for investors to achieve a
positive return on your investment in us will be if the market price of our
common stock appreciates.





Our
directors and officers control approximately one third of our common stock and,
as a result, they may exercise some voting control and be able to take actions
that may be adverse to your interests.





Our
directors and executive officers, directly or through entities that they
control, beneficially owned, as a group, approximately 35.20% of our issued
and outstanding common stock as of September 30, 2010. This concentration of
share ownership may adversely affect the trading price of our common
stock because investors often perceive a disadvantage in owning shares in a
company with one or several controlling stockholders. Furthermore, our
directors and officers, as a group, have the ability to significantly influence
the outcome of all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions,
such as mergers, consolidations or the sale of substantially all of our assets.
This concentration of ownership may have the effect of delaying or
preventing a change of control, including a merger, consolidation or other
business combination involving us, or discouraging a potential acquirer
from making a tender offer or otherwise attempting to obtain
control.





Your
percentage ownership in us may be diluted by future issuances of capital stock,
which could reduce your influence over matters on which stockholders
vote.




Subject
to any applicable stockholder approval requirements imposed by the Nasdaq Stock
Market, our board of directors has the authority to issue all or any part of our
authorized but unissued shares of common stock. Issuances of common stock would
reduce your influence over matters on which our stockholders vote.




- 56
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Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds





None.





Item 3. Defaults upon Senior
Securities




None.




Item 4. (Removed and Reserved)




Item 5. Other
Information





Item
6. Exhibits




The
exhibits listed on the Exhibit Index are being furnished with this report.




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SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




Harbin
      Electric, Inc.Date:
      November 9, 2010
            By:
            /s/ Tianfu
      YangTianfu
      YangChief
      Executive Officer, Director and Chairman of the Board
              (Principal
      Executive Officer)




Date:
      November 9, 2010
            By:
            /s/ Zedong
      XuZedong
      XuChief
      Financial Officer
              (Principal
      Financial and Accounting Officer)







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EXHIBIT
INDEX





Exhibits:




Exhibit Number
            
            Description
            
            Method of Filing10.1
            
            Loan
      Agreement dated July 28, 2010, by and between the Company and Abax Emerald
      Ltd.
            
            Filed
      as Exhibit 10.1 to the current report on Form 8-K filed with the
      Commission on July 30, 2010 and incorporated herein by
      reference.10.2
            
            Option
      Exercise Agreement dated as of August 25, 2010 and effective as of July 1,
      2010, by and between the Company, Advance Automation Group, LLC, Shelton
      Technology, LLC and Ms. Julie Chen.
            
            Filed
      as Exhibit 10.1 to the current report on Form 8-K filed with the
      Commission on August 27, 2010 and incorporated herein by
      reference.10.3
            
            Amended
      and Restated Limited Liability Company Agreement dated as of August 25,
      2010 and effective as of July 1, 2010, by and between Advanced Electric
      Motors, Inc. and Shelton Technology, LLC.
            
            Filed
      as Exhibit 10.2 to the current report on Form 8-K filed with the
      Commission on August 27, 2010 and incorporated herein by
      reference.31.1
            
            Certification
      by the Chief Executive Officer pursuant to Rule 13a-14(a) or
      15d-14(a)
            
            Filed
      herewith as Exhibit 31.1.31.2
            
            Certification
      by the Chief Financial Officer pursuant to Rule 13a-14(a) or
      15d-14(a)
            
            Filed
      herewith as Exhibit 31.2.32.1
            
            Certification
      of the Chief Executive Officer and the Chief Financial Officer pursuant 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002
            
            Filed
      herewith as Exhibit 32.1.





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